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Politics : PRESIDENT GEORGE W. BUSH -- Ignore unavailable to you. Want to Upgrade?

To: DavesM who wrote (130517)	3/6/2001 12:12:10 PM
From: Zoltan!	Respond to of 769670

>>So your saying that in a deflationary depression, banks should pay people to take loans? Sorry, couldn't help myself. It refutes your idea about "low" interest rates. >>As per FDR and Hoover raising tax rates. I bet that the only people who saw high tax rate increases during the 20's and 30's were high income individuals. Proving what? That raising taxes on the upper brackets deepens economic distress and raises little if any additional revenue. The real interest rate is the nominal interest rate plus the rate of deflation, and thus is the interest rate adjusted for deflation. If price levels are falling - and they are expected to continue falling - deflation - then an interest rate of 1% can translate into a much higher real interest rate. In the Great Depression, a nominal "zero" interest rate could be a crushingly high real rate of interest. It's the opposite of what happened in the 1970's with the high inflation. With nominal interest rates at say 6% and inflation running almost double digit, it made sense to borrow because you were paying back in cheaper dollars - paying a negative real interest rate. see william-king.www.drexel.edu ....But what happens when deflation reaches the previously never seen amount of thirty, forty, or fifty percent--as it did in the Great Depression? Banks become keenly aware that their loan principal is no longer safe: that if the borrower defaults, they no longer have recourse to sufficient collateral to recover their loan principal. if the borrower defaults, and if bank depositors take the default as a signal that it is time for them to withdraw their deposits, the bank collapses. As Keynes, wrote, once banks realize that deflation has significantly impaired the value of their collateral: ...they become particularly anxious that the remainder of their assets should be as liquid and as free from risk as it is possible to make them. This reacts in all sorts of silent and unobserved ways on new enterprise. for it means that banks are less willing than they would normally be to finance any project... In looking at the tracks of interest rates in the Great Depression, you can see a steady widening of the gap between safe interest rates on government securities and the interest rates that borrowing companies had to pay. Even though credit was ample--in the sense that borrowers with perfect and unimpaired collateral could obtain loans at extremely low interest rates--the businesses in the economy (few of which had perfect and unimpaired collateral) found it next to impossible to obtain capital to finance investment. Thus the banking system freezes up. It no longer performs its social function of channeling purchasing power from savers to investors. As a result private investment collapses; falling investment produces more unemployment, excess capacity, futher falls in prices, and more deflation; and further deflation renders the banking system even more insolvent. Morever, not only past deflation but also expected future deflation depresses investment. Why invest now if you expect deflation, so that everything you would buy this year will be ten percent cheaper next year?.... econ161.berkeley.edu