Posted on 08/15/2010 6:46:17 PM PDT by Graybeard58
“It the Fed raises rates, we will instantly be in an inflationary spiral as businesses try to spend the trillion dollars in cash reserves they have on their books right now.”
You have it somewhat backwards. Raising real interest rates makes holding cash balances more attractive because you get a return on your savings. People spend cash reserves as fast as they can in response to inflation, for example during the late 70s, when the real interest rate offered on savings was often less than the inflation rate.
Some might argue that the current real rate of interest is positive even while it is nominally zero, due to deflation.
That would depend on what you mean by Keynesian economics. Animal spirits, consumer confidence, are ideas used by almost everyone now. And it was a recent Republican administration that went far beyond Keynes’ modest prescription by claiming that “deficits don’t matter”.
We don’t have inflation though. There is no penalty to holding cash now. Increase the interest rate and there will be.
We don’t have inflation though. There is no penalty to holding cash now. Increase the interest rate and there will be.
A higher interest rate is an incentive to hold cash. You earn more on your savings the higher the real interest rate is.
A low rate, especially a zero interest rate policy like we now have, is a disincentive for holding cash balances because you earn little or nothing on your savings. There is no penalty incurred for spending your money because you are earning nothing on it.
This is a very elementary economic concept. Raising rates does not cause inflation, it is in fact the first tool that the Fed uses to combat inflation. You have the process backwards.
They don’t pay interest on cash. I will grant you that my logic is counter to conventional wisdom but I am saying conventional wisdom is wrong in this instance. We had a story a few weeks ago that businesses are sitting on more than a trillion dollars in cash. Why? Because there is no penalty in doing so. You can’t invest it in stocks and bonds and generate any kind of meaningful positive return anyway right now so why not hold cash? If you push up the interest rate just a little though, then there is a penalty for holding casha nd it would quickly either be spent or invested.
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