- Political stability
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The real cost of money
submited on 06.11.2008 in category Political stability | Fiscal affairs | Monetary policy | Regulated markets | Privatisation | Macroeconomic developments
submited on 06.11.2008 in category Political stability | Fiscal affairs | Monetary policy | Regulated markets | Privatisation | Macroeconomic developments
Manipulating the interest rates is at least part of the explanation for the current financial crisis. This opinion is shared by most observers, which is one of the positive outcomes of the crisis – it focused our attention on the most heavy source of political risk in mature economies today – the central banks. The central banks however make it look like they must be even more active during crisis, as they called it liquidity issue, in order to nominally legitimate their actions.
Now the Federal Reserve continues with the reductions of the official interest rates, which began a year ago. The intended federal funds rate was slashed to 1%. Fed and the ECB declared their determination to pour financial resources into the global financial system, which would increase liquidity and therefore will help banks handle the liquidity crisis.
Irrespective of the Neokeynsian, now modern, crisis terms, it is not driven by lack of cash, but rather lack of real savings. It is more accurate from theoretical standpoint to say that investors have been misled about the ability of savors – those who have real savings – to save a lot for a long time. The monetary policy is the main reason for the wrong signals toward the financial system and therefore toward investors in the real sector. The artificially low interest rates deceived that there are more real savings than there actually were. The true cost of money was however different from the interest rates, set by the central banks.
No matter how much central banks reduce interest rates, this will not increase the volume of real savings, which are at the investor’s disposal. Some investment projects will have to be abandoned because it turns out that there is not really anything to back them up. The liquidation of these enterprises is what is visible during the crisis in the business cycle. Some assets will be reallocated toward other projects, but this will take time. Other investments are forever lost. Both bring certain losses to the economy, which are most popularly reffred to as “recession”.
Will the lower interest rates support the survival of the financial institutions, which have invested irrationally or have excessively relied on attracting external resource? It is possible for this to have short-term positive effect for them. But after all banks and funds will eventually have to liquidate assets, which today cost substantially less than what they had cost before the crisis. Their indebtedness is monetary (they owe money, not assets) and by relying excessively on leverage there is no interest rate, which could save the irrational financial players.
The good news is that lower liquidity is not necessarily related to reduction of real savings. While central banks manipulate liquidity, the real economy determines the volume and the cost of the saved income. The real pool of savings, rather than the official interest rates, will determine investment opportunities and economic growth.
Higher interest rates do not mean less investments. They may compensate savors for inflation of the given currency without resulting in limited investor interest. Liquidity cannot be a problem before the investing of the saved income, at least not for long.
Now the Federal Reserve continues with the reductions of the official interest rates, which began a year ago. The intended federal funds rate was slashed to 1%. Fed and the ECB declared their determination to pour financial resources into the global financial system, which would increase liquidity and therefore will help banks handle the liquidity crisis.
Irrespective of the Neokeynsian, now modern, crisis terms, it is not driven by lack of cash, but rather lack of real savings. It is more accurate from theoretical standpoint to say that investors have been misled about the ability of savors – those who have real savings – to save a lot for a long time. The monetary policy is the main reason for the wrong signals toward the financial system and therefore toward investors in the real sector. The artificially low interest rates deceived that there are more real savings than there actually were. The true cost of money was however different from the interest rates, set by the central banks.
No matter how much central banks reduce interest rates, this will not increase the volume of real savings, which are at the investor’s disposal. Some investment projects will have to be abandoned because it turns out that there is not really anything to back them up. The liquidation of these enterprises is what is visible during the crisis in the business cycle. Some assets will be reallocated toward other projects, but this will take time. Other investments are forever lost. Both bring certain losses to the economy, which are most popularly reffred to as “recession”.
Will the lower interest rates support the survival of the financial institutions, which have invested irrationally or have excessively relied on attracting external resource? It is possible for this to have short-term positive effect for them. But after all banks and funds will eventually have to liquidate assets, which today cost substantially less than what they had cost before the crisis. Their indebtedness is monetary (they owe money, not assets) and by relying excessively on leverage there is no interest rate, which could save the irrational financial players.
The good news is that lower liquidity is not necessarily related to reduction of real savings. While central banks manipulate liquidity, the real economy determines the volume and the cost of the saved income. The real pool of savings, rather than the official interest rates, will determine investment opportunities and economic growth.
Higher interest rates do not mean less investments. They may compensate savors for inflation of the given currency without resulting in limited investor interest. Liquidity cannot be a problem before the investing of the saved income, at least not for long.
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