Get interest rates up

A surprising conclusion

Chris Johns

A listener to our recent podcast recently had occasion to post this thoughtful reply to points we made about the ways the younger generation look to be disadvantaged relative to their parents.

Cian O’Connor @CianOConnor

.@skiduffer @JimPowerEcon you mentioned houses, jobs, pensions, and 18 months of life, but you forgot we also have to pay for boomers’ healthcare, financial crisis, covid borrowing, unwinding your depressed interest rates and, the big one, your climate crisis.

I’d referenced conversations with people somewhat younger than me and the anger they feel about the many ladders my generation have pulled up behind us. I’d listed some, Cian added others to the things that, rightly, anger plenty of people.

I posed a question: why have all those who peer up at disappearing ladders remained so docile? Where are their pitchforks?

‘Just wait’, was the response. In Ireland, the suggestion is that Sinn Fein will be that pitchfork. That is consistent with the way populist governments have popped up in the UK and elsewhere.

If there is a single issue at the top of most lists, it is house prices.

Writer Dan Davies makes a number of related points in this very good piece

Davies despairs (nearly) about the lack of understanding about why house prices, globally, are high and marching ever higher. It’s mostly (but not entirely) about interest rates and bond yields. On our podcast, we talk about bonds a lot and lose listeners every time we do. But they are possibly the most important thing in all financial markets - and non-financial assets, especially housing. Other things could combine to deflate the housing bubble but you are fighting a very strong headwind so long as interest rates hover around zero.

The solution? Create the conditions that will normalise interest rates. Yes, that means get interest rates up. For that to happen, economies have to be run so hot such that wages and most/all other prices go up. For that to happen, governments should, in a blast from the past, target full employment.

We used to be told that wartime government spending and borrowing couldn’t be repeated in peacetime. Then came the financial crisis. And now the pandemic. Who is going to believe the next economist who preaches austerity?

Achieving higher interest rates is not to be desired for its own sake but for what it requires: rising wages and full employment. Government policy that is directed at these two aims will deal with many sources of inequality and have the happy outcome of deflating the housing bubble.

The first stage is to run both fiscal and monetary policy at flat-out maximum: massive government borrowing at zero interest rates. Done for long enough that will achieve full employment and a tight enough labour market that generates those inequality-reducing higher wages. Higher interest rates will follow, eventually.

Sound familiar? Without advertising it explicitly in the terms I have described, this is exactly what the Biden administration is up to. Success is by no means guaranteed but at least they are trying.

Sound unfamiliar? It is exactly what no government in Europe, including the UK, is remotely thinking about.

Until we get enough economic growth that allows central bankers to raise interest rates we are doomed to live in a housing bubble.

Intergenerational equity requires higher interest rates. When you think about it, a lot of other desirable outcomes require higher interest rates. Funny old world.