Willem Buiter Proposes Radical Monetary Measures to Cure the Ailing Economy

Today's macro-economists seem to be of one mind when it comes to one basic cornerstone of their existence: their mission in life is to plan the economy, or failing that, dispense advice to the existing cadre of central planning bureaucrats. One such economist is the current chief economist of Citi Group, Willem Buiter.  Buiter initially rose to prominence by sniping at policy makers from his perch at the Financial Times after the financial crisis had occurred. As we superficially recall, back then his missives often tended to be marked by a fairly good diagnosis combined with often bewildering proposals for mending the situation. Not much has changed on the latter account.


Last week, Buiter used the Wall Street Journal as a platform to editorialize in the direction of the Fed with his latest policy recommendations, entitled 'Is this the Right Time for the Fed to go Negative?'.

We should note here that the only recommendation we have for the Fed is to arrange for a smooth transition to an honest free market-based money while it is abolished. It seems almost superfluous to discuss the minutiae of its policies given that no attempt to centrally plan money and interest rates can possibly succeed. In that sense it seems superfluous to even discuss concrete policy proposals, but sometimes something comes along that is so incredibly 'out there' that it still seems worthy of comment. Buiter begins by noting:


“Ben Bernanke, chairman of the Federal Reserve Bank, has a lot more tools for supporting U.S. economic activity through expansionary monetary policy than he discussed in his Jackson Hole speech, which alluded only to more quantitative easing and credit easing — increasing the size and changing the liquidity composition of the Fed's balance sheet.

Perhaps out of fear of resurrecting the moniker "Helicopter Ben," Mr. Bernanke did not refer to the combined fiscal-monetary stimulus that (almost) always works: a fiat money-financed increase in public spending or tax cut. Treasury Secretary Tim Geithner can always send a sufficiently large check to each U.S. resident to ensure that household spending rises. By borrowing the funds from the Fed, there is no addition to the interest-bearing, redeemable debt of the state. As long as households are confident that these transfers will not be reversed later, "helicopter money drops" will, if pushed far enough, always boost consumption.”


Sounds like a free lunch, doesn't it? We should do it all the time … if not for a few quibbles we have. We would note here that any 'fiat money financed' push to 'increase consumption' not only doesn't work (i.e. contrary to Buiter's assertion that it 'almost' always works', it never does), but actually damages the economy further. Economic activities need to be funded, and printing money is not the same as providing real funding. The erroneous assumption that printing more money 'works' is based on a misunderstanding of cause and effect, and a misapprehension of temporal leads and lags. In essence, as long as the pool of real funding (the pool of unconsumed production) is still increasing, an injection of money will create the short term illusion of boosting the economy –  as essentially unprofitable, wealth-destroying activities will commence. However, in reality, impoverishment occurs, as capital will inevitably be consumed in the process. The assumption – implicit in this paragraph –  that one can get richer by 'boosting consumption', is the functional equivalent of suggesting that a famine is best dealt with by eating more.

Alas, Buiter then goes on to argue that boosting consumption is not really his goal anyway. He states:


“However, stronger consumer expenditure, while appropriate from a cyclical perspective — any additional demand is welcome — is not what the U.S. needs for long-term sustainability and structural adjustment: to raise the national saving rate, boost fixed investment in plant, equipment and infrastructure, achieve a trade surplus and shift resources from the non – tradable to the tradable sectors.  By way of illustration, an eight percentage point reduction in public and private consumption as a share of GDP could be compensated for by an increase in the trade surplus of five per cent of GDP and in non-housing U.S. fixed capital formation of three per cent of GDP.”


Let us first point out that while the enabling of consumption is certainly the end of all economic activity – we produce so that we may consume – consumption is generally the result, or effect of production. It matters little whether anyone thinks it would be 'appropriate from a cyclical perspective if people consumed more' (which is by itself a highly dubious claim). What matters is if the stuff that people are supposed to consume is actually produced. In fact, what matters is not only that the stuff is produced, but that what is produced is what people desire to consume. It should be self-evident that this array of choices – what to produce, what to consume, and how much of it – is best left to the free market.

The same principle applies to the economic activities that Buiter deems worthy of boosting. We agree that the economy is savings-starved and likely in need of more savings. This is by way of simple deduction – the Fed's policies have been inimical to saving for decades. Increasing fixed investment in plant, equipment and infrastructure certainly sounds like a good idea in principle, but what kinds of investments? It is not as if that didn't matter. In an unfettered free market we could be quite certain that on balance, the correct economic mix and balance between production and consumption would emerge. Buiter thinks what is needed is a boost in 'non-housing fixed capital formation and exports'. The latter is based on the assumption that a trade deficit is a negative datum per se.  However, when people trade with each other, they do so because both parties to the trade deem it to be to their advantage. The idea that the existence of national borders somehow creates 'good' and 'bad' outcomes for voluntary trade is nonsensical a priori.  People do not require a 'policy' to engage in voluntary trade that is to their economic advantage. What they do need is a tearing down of all trade barriers. The best trade agreement between nations fits on less than half a page: all it needs to say is 'henceforth, all trade between individuals residing in our nations shall be completely free'.

Anyway, Buiter believes the US requires a 'trade surplus'. The fact that trade  deficits and surpluses are seen as a potential economic problem nowadays is a direct result of the world-wide use of inflationary free-floating fiat currencies, but we digress.


The 'Zero Bound Problem'

Assuming that hypothetically, the shift in the economy's structure that Buiter proposes were desirable, how is that shift going to be achieved? According to Buiter, the real problem is apparently that money is still too expensive, even at zero interest rates. All that is required is to weaken the exchange rate and lower the already negative real interest rate even further. This is a good example of the failure of one government intervention (zero interest rate policy) begetting a hue and cry for even more intervention:


“To achieve this, a much weaker real exchange rate and lower real interest rates are necessary. To pursue these objectives speedily a Federal Funds target rate of around minus three or minus four per cent may well be required right now, in our view. This brings monetary policy up against the zero lower bound (zlb) on nominal interest rates.”


This nonsense is actually not new. The first economist to propose a similar 'solution' to our economic problems after the GFC ('great financial crisis') was Harvard economics professor Gregory Mankiw, who penned an article entitled 'It May Be Time for the Fed to Go Negative' back in April of 2009 already. Yes, the same Gregory Mankiw who enthusiastically declared in late 2007 that economic recession would be definitely avoided, because:


“The truth is that the current Fed governors, together with their crack staff of Ph.D. economists and market analysts, are as close to an economic dream team as we are ever likely to see.”


That didn't quite work out as expected. Anyway,  Buiter is just rehashing what may have been Mankiw's worst idea ever – negative interest rates. How people are going to be induced to increase their savings when interest rates are actually negative is quite beyond us – remember, increasing the savings rate is one of Buiter's stated goals. We do however agree that this policy would be a good method for crashing the dollar – and as everybody knows, a sure sign of the imminent return of prosperity is when your currency is crashing.

Robert Murphy remarked in connection with Mankiw's original proposal:


Mankiw's article beautifully illustrates what is wrong with today's economics profession: it consists of very sharp guys (and gals) who can develop interesting models that spit out policy recommendations that would destroy the economy.”


We strongly recommend reading Murphy's entire piece, but want to highlight one particularly important point here: interest rates do more than just 'regulate spending'. They govern the inter-temporal coordination of production and consumption. It is precisely because a too loose Federal Reserve policy in the wake of the Nasdaq bust led to an intertemporal dis-coordination of the production structure that we are now in the mess we find ourselves in. How doing more of the same is going to fix this problem is quite mysterious, but it remains the favored recommendation of macro-economists far and wide.

Having identified the alleged problem of the 'ZLB' (as to the 'zero lower bound' – with negative interest rates representing a complete absurdity, it is generally acknowledged that they can not be cut below zero, so Keynesians everywhere have seized on the 'ZLB' as a major problem that stands in the way of more inflation), Buiter continues:


“The zlb results from the existence of currency (dollar bills and coins) with a zero nominal interest rate. Even allowing for "carry costs" of currency (storage, safekeeping, insurance etc.), this makes it impossible for competing assets like government bills, to offer interest rates much below zero. Stimulating demand in the U.S. economy, while rebalancing the composition of demand and production in the desired directions, requires a much lower Federal Funds target rate than is feasible with the zlb in placeTo restore monetary policy effectiveness in a low interest rate environment when confronted with deflationary or contractionary shocks, it is necessary to get rid of the zlb completely. This can be done in three ways: abolishing currency, taxing currency and ending the fixed exchange rate between currency and bank reserves with the Fed. All three are unorthodox. The third is unorthodox and innovative. All three are conceptually simple. The first and third are administratively easy to implement.”


(our epmphasis)

Holy Moses, preserve us! We agree with Buiter that the composition of demand and production have been left unbalanced as a result of the credit boom/bubble, but the only way to achieve the 'desired rebalancing' is to allow the free market to work. Obviously, a negative interest rate would simply not exist in a free market (more on interest rates follows). Abolishing or taxing currency? That inflationist idea is ages old, and has been rejected by serious economists ever since it was first uttered – for good reason.


What Money Is and Has Become

Let us step back for a moment and think about what money actually is and how it came into existence. Obviously, the modern economy with its division of labor could not exist without money. Money arose in the market by a process of trial and error – at first, exchange was based on barter. The problem with barter is that it requires a coincidence of wants. The shoemaker can only barter shoes with the baker in exchange for bread if the baker actually needs new shoes. Thus people began over time to narrow down which good was actually the most marketable good and thus most suitable for rendering the services of money. This in short is the origin of money – the most marketable good was chosen to serve as the medium of exchange. Note here that this could only be a good that was already in demand, i.e. before it was used as money, there already existed a non-monetary demand for it. Otherwise it could not have become money.

The banknotes that have these days become completely unbacked fiat currency by means of legal tender laws imposed by the State (what Buiter refers to as currency above), originally were warehouse receipts designating a definitive amount of actual money held in storage and were redeemable for money on demand (for most of economic history this money would consist of precious metals like gold and silver). After the State usurped the prerogative of money issuance for itself and proceeded to remove the connection between the banknotes and the original market-chosen money for which they represented the receipts, the notes themselves became our 'currency' – they now serve as actual money, in spite of being 'backed' by nothing but debt. By making this unbacked paper the sole means of discharging both public and private debt by legal tender law and creating a secondary market by designating it the only money accepted for payment of taxes, the State has managed to get people to accept and use this money substitute as though it were actual money. It is important to remember though that it remains an artificiality. In a free market such a money could not exist – it only exists by coercion. Nevertheless, this money now represents our medium of exchange, and is therefore ipso facto, money.

As we have previously mentioned in articles referring to the money supply,  (disregarding the fact that the current medium of exchange is far from ideal and imposed by political diktat as opposed to representing a money freely chosen by the market),  actual currency – bank notes and coins – are money, whereas demand and savings deposits represent a perfect money substitute, as they share the decisive 'present good' characteristic with currency. This is to say, deposit money can be used for immediate payment (by  check or transfer) and moreover is exchangeable for currency on demand. Due to the Federal Reserve's policy of constant inflation (the US dollar's purchasing power was stable prior to the Fed's arrival on the scene, but has lost 96% of its purchasing power in the century since the Fed has become operative), this money is highly unstable to say the least. While 'stability' is not a desirable feature in and of itself – the exchange value of money would fluctuate in a free market too – the fact remains that the Fed is constantly devaluing the money it issues. This presents a considerable challenge for actors in the economy, as they have to constantly devise schemes to somehow preserve the purchasing power of their savings. According to Buiter this is not enough. The problem needs to be compounded, in order to get spending going again in the 'desirable direction'.


Abolishing Currency and the Invocation of past Monetary Cranks

Buiter then points out the alleged evils of currency circulating outside of the banking system:


“The first method does away with currency completely. This has the additional benefit of inconveniencing the main users of currency — operators in the grey, black and outright criminal economies. Adequate substitutes for the legitimate uses of currency, on which positive or negative interest could be paid, are available.”


As far as we know the 'main users of currency' are not only shady criminal types. Certainly both governments and banking cartels everywhere would love nothing more than to implement this crypto-fascist proposal under the guise of 'hampering criminal activity'. In reality it would destroy all vestiges of financial privacy, by making every financial transaction traceable for the bureaucrats. In addition it would deprive citizens of an important right – the right to remove their savings from the banking system.

It would mean that in the event of a financial crisis like the one in 2008 that nearly crashed the system, people would  no longer have the choice of withdrawing their money from the system. They would sink or swim with the banks. We would recommend saying 'thanks, but no thanks' to that idea, even though it is quite clear that the government will bail out the big banks no matter what. The problem is that people relying on government promises to this effect have been left stranded with their savings utterly destroyed too many times in history to make such an approach even remotely acceptable. Just ask the citizens of Argentina, who were subjected to a grueling confiscatory deflation when push came to shove. When the choice is between protecting savers or protecting the big banks, governments as a rule always favor the big banks. It should also be pointed out that the so-called 'gray economy' – economic activity that takes place outside the purview of the tax man – does not exist because people are inherently prone to cheating. It exists because the burden of taxation in the Western democracies is so onerous that most people would simply be unable to afford certain services if they could not obtain them free of tax.

Buiter wants to crash the gray economy? If this were to succeed, it would result in one of the biggest collapses of living standards since the disintegration of the Roman Empire. The inflationist emperor Diocletian attempted just such a thing by introducing price controls the violation of which was subject to severe punishments – and ultimately the empire's entire economy crumbled. Naturally, governments everywhere know that it would not be possible to control the gray economy in this manner. Instead of halting all 'gray' economic activity,  people would begin to use other currencies. In short, the legitimacy of the existing fiat money would be severely challenged by doing away with bank notes.

If Buiter's goal is to crash the dollar, then this would certainly be one way of achieving that. The dollar is especially vulnerable in this regard, as it is used as an alternative currency all over the world –  many people who do not trust the monies their own governments issue have taken to saving and transacting in US dollars. A recent pertinent example is Zimbabwe, where  all economic exchanges would have had to revert to barter had it not been for the availability of US dollars, South African Rand and gold.

What about the 'adequate substitutes for legitimate uses of currency on which negative interest rates could be paid'? How do pray tell do you 'pay' negative interest rates? Who would designate what constitutes a 'legitimate use of currency'? Buiter seems eager for a financial police state rivaling the dystopia   of Orwell's 1984.


“The second approach, proposed by Gesell, is to tax currency by making it subject to an expiration date. Currency would have to be "stamped" periodically by the Fed to keep it current. When done so, interest (positive or negative) is received or paid.”


Silvio Gesell in his time was generally viewed as a 'monetary crank', which describes him well. Perhaps not too surprisingly, John Maynard Keynes approved of his inflationist ideas. As Joseph Salerno writes of Gesell's currency taxing scheme and its modern-day proponents :


Recognizing the inability of their sophisticated models to predict or even explain the financial collapse and subsequent Great Recession, leading macroeconomic theorists of the day have lapsed back into raw and simplistic Keynesianism. They call for ever more fiscal and monetary stimulus via massive deficits and zero interest rates. These traditional stimulus policies have failed to ignite a strong recovery even though they were implemented on a massive scale.

But the manifest failure of such policies does not give their proponents pause; it only incites them to propose ever more bizarre schemes. One such proposal is inspired by the monetary crank Silvio Gesell, who Keynes once called a "strange, unduly neglected prophet." The modern version of Gesell's plan calls for a tax on the public's bank deposits and currency holdings as a means of driving nominal interest rates below zero and thereby stimulating total spending.”


Ludwig von Mises states in 'Human Action', chapter XXXI., 'Currency and Credit Manipulation', that Keynes was merely restating the inflationism of Gesell and others in a more 'scientific' looking cloak of mathematical economics:


“Keynes did not add any new idea to the body of inflationist fallacies, a thousand times refuted by economists. His teachings were even more contradictory and inconsistent than those of his predecessors who, like Silvio Gesell, were dismissed as monetary cranks. He merely knew how to cloak the plea for inflation and credit expansion in the sophisticated terminology of mathematical economics. The interventionist writers were at a loss to advance plausible arguments in favor of the policy of reckless spending; they simply could not find a case against the economic theorem concerning institutional unemployment. In this juncture they greeted the"Keynesian Revolution" with the verses of Wordsworth: "Bliss was it in that dawn to be alive, but to be young was very heaven." It was, however, a short-run heaven only. We may admit that for the British and American governments in the 'thirties no way was left other than that of currency devaluation, inflation and credit expansion, unbalanced budgets, and deficit spending. Governments cannot free themselves from the pressure of public opinion. They cannot rebel against the preponderance of generally accepted ideologies, however fallacious. But this does not excuse the officeholders who could resign rather than carry out policies disastrous for the country. Still less does it excuse authors who tried to provide a would-be scientific justification for the crudest of all popular fallacies, viz., inflationism.”




Silvio Gesell, anno 1895 – he wanted interest rates to be at zero at all times, and invented the so-called 'Freigeld' – a money that would automatically lose its value over time. In that sense not all that different from our modern day fiat money actually.

(Photo Credit: Wikimedia Commons)



The funny thing is, Buiter does not even attempt to provide a justification for his advocacy of extreme inflationist measures. His entire screed at the WSJ invokes his inflationist 'solutions' as though it were perfectly self-evident that they should be pursued. He spends the entire editorial with explaining the mechanics of his scheme – not a single sentence is wasted on telling us why exactly its implementation would result in his desired goals of a higher rate of savings, growth in non-housing fixed investment as well as a trade surplus! Naturally if the dollar crashes a trade surplus may well ensue as the US becomes unable to pay for foreign goods. But would it be worth it? Consider us  doubtful on that account, to put it mildly.


Enter the Bizarro dollar

Buiter's pet project appears to be the third 'solution', presumably because it involves a more complex shell game and is thus in keeping with the shell games already played between the Fed, the commercial banks and the government.   Under the hood it is no different from the other ideas. It is an attempt to make the currency worthless as quickly as possible. Say hello to the 'rallod' – i.e., the Bizarro dollar:


“The third method ends the fixed exchange rate (set at one) between dollar deposits with the Fed (reserves) and dollar bills. There could be a currency reform first. All existing dollar bills and coin would be converted by a certain date and at a fixed exchange rate into a new currency called, say, the rallod. Reserves at the Fed would continue to be denominated in dollars. As long as the Federal Funds target rate is positive or zero, the Fed would maintain the fixed exchange rate between the dollar and the rallod.

When the Fed wants to set the Federal Funds target rate at minus five per cent, say, it would set the forward exchange rate between the dollar and the rallod, the number of dollars that have to be paid today to receive one rallod tomorrow, at five per cent below the spot exchange rate  — the number of dollars paid today for one rallod delivered today. That way, the rate of return, expressed in a common unit, on dollar reserves is the same as on rallod currency. For the dollar interest rate to remain the relevant one, the dollar has to remain the unit of account for setting prices and wages. This can be encouraged by the government continuing to denominate all of its contracts in dollars, including the invoicing and payment of taxes and benefits. Imposing the legal restriction that checkable deposits and other private means of payment cannot be denominated in rallod would help.”


Good grief. So currency would become the Bizarro dollar, while all money within the banking system would remain denominated in the 'old dollar'.  The banks would love that, as the effect would likely be similar to that of outlawing paper currency altogether. People would be facing the unappetizing choice of drawing their money out in form of 'rallods' – which presumably everybody would try to get rid of as fast as possible – or keeping their money in the bank as 'dollars'. Naturally, given the mechanics of credit money inflation in a fractionally reserved system (see the chapter on the 'money multiplier' in a previous missive as to how this works), every cent that is circulating as currency outside of the banking system markedly lowers the ability of the banks to inflate loans and deposits.

This way they could be quite sure that most money would remain within the system. Buiter's proposal seems to have a secondary – undisclosed – aim of keeping bank runs at bay. With a central bank able to create bank reserves from thin air this shouldn't really be a problem, especially not for the 'too big to fail' banks (for one of which Buiter now works), but maybe they are all casting a wary eye at Greece, where the deposit base of banks has been shrinking rather quickly of late.

This not only hampers the ability of banks to inflate money and credit, but as a side effect  also impinges on their ability to skim profits from the productive sectors of the economy. Given that the banking sector would as a true financial intermediary only earn a tiny fraction of what it earns now (currently financial profits dwarf the profits of all other sectors of the economy), it is understandable that it wants its privileges enshrined and preserved in any way possible. Destroying the currency component of the money supply would certainly be 'helpful' in this regard.


World-wide Inflation would be best….

Buiter not only wants to see negative interest rates implemented – he also thinks that in some places 'helicopter drops of money' are called for as well (he has inflationist ideas for the whole world).


“In the other major industrial countries too (the euro area, Japan and the U.K.), monetary policy is constrained by the zlb. Conventional fiscal expansion with government debt-financed deficit increases would be ineffective or infeasible because of fiscal unsustainability. Like the Fed, the ECB, the Bank of Japan and the Bank of England therefore should lobby for the legislation necessary to eliminate the zlb. The euro area and Japan, which don't suffer from deficient saving rates or undesirable current account deficits, could in addition stimulate consumption through helicopter drops of money — base money-financed fiscal stimuli.”


In view of the enormity of his proposals it seems almost anti-climactic to  point out that if the US were to run a current account surplus, then someone else would by necessity be running a deficit, so presumably the euro area and Japan might then face those 'undesirable current account deficits'. Someone would. This internationalist afterthought of Buiter's is a tacit admission that his scheme would backfire rather immediately if it were implemented by the US unilaterally, as the dollar would likely crash against the other fiat monies. So according to Buiter, deficit spending would be cool too, if not for the problem of 'fiscal unsustainability' (thrown recently into stark relief by the troubles the PIIGS are facing). So let's all go for the Zimbabwe solution instead! You really couldn't make this up.

Buiter ends his article with an admonition to give his 'unorthodox' ideas a whirl in spite of the ingrained 'conservatism' of central banks:


“All three methods for eliminating the zlb, although administratively feasible and conceptually simple, are innovative and unorthodox. Central banks are conservative. The mere fact that something has not been done before often is sufficient grounds for not doing it now. The cost of rejecting institutional innovation to remove the zlb could, however, be high: a material risk of continued deficient aggregate demand, persistent deflation and, in the U.S. and the U.K., unnecessary conflict between short-term stabilization and long-term sustainability and rebalancing.


The cost of adopting his proposals would certainly be a lot higher. As Murphy says, it is an example of how seemingly smart economists can cook up ideas that could potentially end up destroying the economy. The proposals in question surely would destroy the currency for a start. Besides, it is debatable how 'innovative' these notions are. Gesell and other inflationists of his time (Waddill and Catchings for example)  have all proposed similar ideas. Of course the measure of an economic doctrine is not its age; it is its soundness. Buiter's proposals are no doubt 'unorthodox', but that doesn't change the fact that they are truly bad ideas.


Interest Rates – What Are They Really?

As far as we can tell one of the reasons why such loopy proposals even see the light of day is that Keynesian economic text books contain no tenable theory of interest. Keynes had a 'liquidity preference' theory of interest that regards interest rates as purely a monetary phenomenon. The main idea propagated  by Keynes appeared to be that interest was somehow 'bad' and would best be pushed as low as possible. It only benefits the 'rentier', who according to Keynes should be subjected to 'euthanasia'. Keynes believed that the problem of economic scarcity could be solved by keeping interest rates as close to zero as possible.

However, the originary, or natural interest rate is merely a price ratio – an expression of time preference. It reflects the fact that present goods are valued more highly by human beings than future goods. An apple you can get today is worth more to you than an apple you can get a year from now. The difference between these two valuations is called interest. That is really all it is. It implies, since man is always constrained by this time preference – that the only way for him to prefer future goods over present ones is if he can expect to be provided more of the future goods by abstaining from consumption in the present.

It follows from this that this time preference must at all times be positive for everyone and that interest is a real phenomenon, not a monetary one. Everything else – the social rate of time preference (the market interest rate where all individual sets of time preference intersect), the interest rate charged in the market for loanable funds –  flows from this real phenomenon. Mises writes in Human Action on the originary interest rate:


“Originary interest is the ratio of the value assigned to want-satisfaction in the immediate future and the value assigned to want-satisfaction in remote periods of the future. It manifests itself in the market economy in the discount of future goods as against present goods. It is a ratio of commodity prices, not a price in itself.”


He further notes that interest is not, as is widely thought, the 'price paid for the services of capital'. Mises also asserts that the employment of more productive production processes is not a satisfactory explanation of interest.


“Originary interest is not "the price paid for the services of capital." The higher productivity of more time-consuming roundabout methods of production which is referred to by Böhm-Bawerk and by some later economists in the explanation of interest, does not explain the phenomenon. It is, on the contrary, the phenomenon of originary interest that explains why less time-consuming methods of production are resorted to in spite of the fact that more time-consuming methods would render a higher output per unit of input.”


Mises then further shows that we must concentrate on the real phenomenon of interest, the time preference that is a category of human action – and that everything else follows from there:


“Originary interest is not a price determined on the market by the  interplay of the demand for and the supply of capital or capital goods. Its height does not depend on the extent of this demand and supply. It is rather the rate of originary interest that determines both the demand for and the supply of capital and capital goods. It determines how much of the available supply of goods is to be devoted to consumption in the immediate future and how much to provision for remoter periods of the future. People do not save and accumulate capital because there is interest. Interest is neither the impetus to saving nor the reward or the compensation granted for abstaining from immediate consumption. It is the ratio in the mutual valuation of present goods as against future goods. The loan market does not determine the rate of interest. It adjusts the rate of interest on loans to the rate of originary interest as manifested in the discount of future goods. Originary interest is a category of human action. It is operative in any valuation of external things and can never disappear. If one day the state of affairs were to return which was actual at the close of the first millennium of the Christian era when some people believed that the ultimate end of all earthly things was impending, men would stop providing for future secular wants. The factors of production would in their eyes become useless and worthless. The discount of future goods as against present goods would not vanish. It would, on the contrary, increase beyond all measure. On the other hand, the fading away of originary interest would mean that people do not care at all for want-satisfaction in nearer periods of the future. It would mean that they prefer to an apple available today, tomorrow, in one year or in ten years, tow apples available in a thousand or ten thousand years. We cannot even think of a world in which originary interest would not exist as an inexorable element in every kind of action. Whether there is or is not division of labor and social cooperation and whether there is or is not division of labor and social cooperation and whether society is organized on the basis of private or of public control of the means of production, originary interest is always present.”


(our emphasis)

Mises concludes this chapter with the following admonition:


“[Therefore] there cannot be any question of abolishing interest by any institutions, laws, or devices of bank manipulation. He who wants to "abolish" interest will have to induce people to value an apple available in a hundred years no less than a present apple. What can be abolished by laws and decrees is merely the right of the capitalists to receive interest. But such decrees would bring about capital consumption and would very soon throw mankind back into the original state of natural poverty.”


We can see from this that even the so-called ZIRP (zero interest policy) violates a fundamental economic law and is inimical to economic progress. Buiter wants to stand the natural state of affairs completely on its head – according to his proposal, the monetary authority should declare that henceforth, time preference should work the other way around – present goods should be valued lower than future goods. The process of discounting the value of future goods would be forcibly reversed. This simply can not work. It would render the process of rational capital allocation impossible – and it would destroy the currency. In fact, it is a very good bet that people would stop using a currency afflicted by such a decree.

Assuming that negative interest rates were to be imposed, the government would soon feel compelled to resort to additional impositions, from price controls to bans on the use of alternative currencies. Contrary to channeling economic outcomes in the 'desired direction' preferred by Buiter, the end result would be a completely paralyzed economy with the trappings of a police state.



Citi Group chief economist Willem Buiter: walking in Silvio Gesell's and Gregory Mankiw's inflationist footsteps. In spite of all theoretical and practical evidence to the contrary, many economists seem unable to let go of the notion that prosperity can be brought into being by inflationary means.

(Photo Credit: Cristopher Cox)



Ludwig von Mises: A life-long enemy of the inflation of money and credit and the illusion of prosperity it brings. As he explained, a zero or negative interest rate is actually not possible in the real world of purposeful human action.

(Photo Credit: Wikimedia Commons)




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2 Responses to “A Dose of Buiternomics”

  • easypilot:

    If it was like mr. buiter says, why instead of working or dedicating time to businessess everybody doesn’t simply buy a little printer to print money by himself? According to mr. bernanke and co. it should work…even a baby can realize that it won’t…

    • Many of today’s prominent macro-economists strike me as the equivalent of medieval quacks. They purport to engage in science, but their recommendations and analyses are often truly hair-raising nonsense.
      There are no places at the public trough for free market oriented economists, so as a rule it is often a case of not wanting to bite the hand that feeds them. Thus the subject of State intervention in the economy is ‘off limits’. It is assumed as a given that it should be pursued (mind there are of course also many economists who do very good work, but they are the minority and they are usually not in prominent influential positions).
      Willem Buiter is both prominent and has in the past been noted for quite readable critical appraisals of the financial crisis. I really wonder why he proposes an idea that flies so obviously in the face of common sense and sound economc theory. You don’t have to be an Austrian scholar to understand that the natural interest rate can not possibly be negative, and he can not be so naive as to believe that banning the use of currency and introducing negative rates would not lead to major market upheaval. The whole thing is a bit of a mystery, but one must speak out against it before the merry pranksters at the Fed get the idea to try it out.

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