EconBuff Podcast #17 with Ryan Mattson
Dr. Ryan Mattson talks with me about time inconsistency in recent monetary policy. We discuss what what time inconsistency is and why it is important. Dr. Mattson gives his view on excessive leverage in the banking sector and how regulation has impacted it. We talk about the effects of effects of low interest rates and the damage they might be causing. We consider what policies might be put in place to attempt to mitigate the effects of negative interest rates and what the limitations of that are. Dr. Mattson lays out the short run effects of negative interest rates and how that impacts private banks and the shadow banking system. We explore the long term problems stemming from persistently low rates, what mechanisms negative interest rates might effects banks through and how Dr. Mattson views our options for getting away from negative interest rates.
Transcript
Stitzel: Hello and Welcome to the EconBuff Podcast. I'm your host, Lee Stitzel. With me today is Dr. Ryan Matson, Professor of Economics at West Texas A&M University. Ryan, welcome and welcome.
Mattson: It's great to be here again Lee.
Stitzel: So Ryan, our topic today is time inconsistency in recent monetary policy. We're inspired by the publication of the same name by Charles Goodhart, and with his co-authors [Tatjana] Schulze and [Dimitri] Tsomocos. Did I get that right?
Mattson: (Agrees, Yes) Hmm. Tsomoscos.
Stitzel: Tsomoscos. Okay, excellent piece. I'll put a link up to that on the web page when we get this to that point. So I want to start off, this is one of the most critical things that I do in my graduate classes: teach about time inconsistency and monetary policy. I see this as an extremely important topic, I think especially given what The Federal Reserve has been doing in response to COVID (and the recession that we're in and we find ourselves in), which maybe you and I will find some time in this podcast to talk about the depth of that (and maybe where we see that going). I don't think there's a better time to talk about time inconsistency than now. So when I say time inconsistency, I mean this idea that (a policy maker) a policy is time inconsistent when a policy maker has an incentive to make a commitment at one point in time and less incentive to keep it when it comes to that -- when it comes time to hold to that policy. So a good example of this would be bailouts, right? And so what I want to do is: I say I'm not going to bail you out. You engage in a risky behavior. Now you need bailing out. I don't have the same incentive once you've engaged in that behavior and gotten yourself in trouble. To not bail you out but that creates these types of incentive problems. So Ryan, start us off by talking about how you see time inconsistency in our recent monetary policy choices.
Mattson: Sure, and I really like this article that she turned me on to, by the way, because the rigorous definition is great for the classroom, and what you've explained there is good. I think the other way to approach that time inconsistency problem is to look at what concrete effects that it has in the short and long run. And this article does a great job of doing that, bringing it down to both the short and long run effects, starting with say the yield curve, [i.e.] the measurement of the yield curve. This issue of the term premium, which is going to be a really important relationship between time and rates, or rates of return on bonds. But then also moving into some of the longer term problems of persistently low rates. And they really do a nice focus on the issue of household debt in Europe, which I think as we go on with our conversation, may not be something as, may not be as large for the U.S. as it is for Europe. But I think we're going to get to that. The time and consistency problem from a monetary policy perspective comes in basically just to say that, you know, if you keep these rates at zero or extremely low for so long; [whereas], what happens over the long term, when maybe you do want to raise rates given another given another inflation crisis? I would say that'd be the only time when they'd want to raise it. And then even that, let's say we have great recession in 2008-2009. We lower interest rates to zero. And then by 2011-2012, [the] stock markets back up [and] banking seems to be profitable again. But maybe the rest of the real economy and manufacturing retail hasn't quite recovered. So they're going to want to try and keep it low for a bit longer, when maybe if they were following a Taylor Rule or a Money Growth Rule, they would want to have begun raising those interest rates earlier than when they started in about 2015-2016. And the fact that they had those rates so low for a decade has real effects on what's going on. So that's at least how I see this time inconsistency problem from a monetary policy perspective.
Stitzel: You've set that up perfectly. What I like that you drew out there is to say: we have real effects in the economy [and] real consequences for holding interest rates so low for so long. I think last time I had you on, perhaps, we were talking about this idea of you've given yourself no ammunition.
Mattson: (Agrees)
Stitzel: And you talked about some of the other the new unconventional things that…
Mattson: Yeah, quantitative easing. Now they're buying equities outright, I mean, it's yeah….
Stitzel: And negative interest rates on reserves held with The Federal Reserve, stuff like that. So I really think that's what I want to focus on today is talking about: what are the consequences of those negative interest rates? To set that up, I kind of want to go back and find the grounding in the financial crisis. So I think it's universally understood (you can correct me if that's wrong) that the financial crisis is primarily caused by excessive leverage in the banking sector?
Mattson: Yes, very excessive leverage. Off the top of my head (but we should check this), I want to say that a leverage ratio of 32:1, meaning you know for every dollar coming in you have 32 dollars that maybe needed to go out at some point in time. So yeah, excessive leverage leading up to 2008-2009.
Stitzel: So we've seen a lot of regulatory response. So my first question is: has this type of excessive leverage in the banking sector - has it been reduced by that regulation that we've seen in the last 10 years?
Mattson: So I'm doubtful. I'm skeptical that it actually has been. One of the issues that I find with regulations is that you're imposing much more costs on the medium or small asset banks ([i.e.] banks that are not holding say you know billions and billions in their assets and lending out). They're the ones that are going to face a cost of hiring the lawyers and dealing with these regulations. And then at some point it's probably going to hit that that reserve cost, where they decide that it's no longer worth it, and the bank just closes under. The larger banks are the ones that can afford to go around these regulations [and] continue to do business as they want to do. And, you know, if you look at the leverage ratios today, I mean, is it lower than 30:1? Yes, but some of those measurements much like we had in 2008-2009 (I'm a big measurement fan). And so, I always go back to the shadow banking system, you know, things like overnight repurchases, money market, mutual funds. And a lot of these things have been growing and growing and growing again, which is good; but, at the same time that could increase some of that risk. And we have, you know, the top five big banks increasingly placing [and] (you know, as the economy stabilized after the great recession which is again wonderful but) increasingly using the shadow banking system for liquidity, and growing that shadow banking system (again which we're not measuring very well). So I think that, and this is my opinion (so you know you can roast me in the comments all you want). I think that we are under-measuring the leverage that we currently have right now. And I honestly, I don't know how much more it would be, but I would say the number is probably much higher than we think it is.
Stitzel: So we've done this before. Define shadow banking for us, because I think that's…
Mattson: Sure.
Stitzel:…a perfect term for a relatively straightforward idea.
Mattson: Yeah. Yeah. So the shadow banking system is just an unregulated financial institution. They provide the services of a bank, without being regulated, or at least not strongly regulated by the FDIC in The Federal Reserve. Although, since The Federal Reserve has made inroads into measuring and regulating this market as well. But of course people, you know, when you put a regulation on something, people are going to find a way around it. So that’s….
Stitzel: So can I summarize your point then, by saying we probably have seen some excessive leverage being reduced in the in the public sector?
Mattson: Yes.
Stitzel: We got the shadow banking problem. I hate to call it a problem, because I don't want to give people this intuition like shadow banking is bad.
Mattson: Yeah.
Stitzel: I mean specifically the amount of leverage in the…
Mattson: Yes. Yes.
Stitzel: …shadow banking side. Okay. Excellent! So now we've had low interest rates for such a long time. Do you see low interest rates as having made private and public sector businesses worse, because these low interest rates encourage risk seeking? And does this maybe make that private sector? And maybe define for us: start by talking about the difference or non-difference between the private sector and shadow banking.
Mattson: Sure. So, well yeah. I, at least in terms of what I'm thinking, I mean, shadow banking is very much part of the private sector.
Stitzel: Right.
Mattson: I would say even, you know, the lower interest rate is going to drive those large banks further into the shadow banking system, because that's the only place they're going to find return. You're not going to get money off of CDs, or savings accounts, or checking accounts. So you need [and] investors need to find some place to get those returns. And of course, Lehman. Sorry Lehman's been gone for a while, and I still say Lehman, first off. Goldman Sachs, and firms like Lehman Brothers, were created to provide that opportunity [and] were created to do that. That's their job [and] is their job. So yes, it not only increases this risk, but it incentivizes more people to play in the risky market. In the same way, you know, okay, I'm getting very low interest on my savings account and CDs; and so I'm starting to look at my equity portfolio, and think well maybe I want to put more in here. Because at least I can get, you know, I don't know if I'm lucky, maybe what? Three percent return? Four percent return? If I'm really, really lucky, maybe hit that five? You know, with my savings account it's zero, or effectively zero, not keeping up with inflation, in fact, I might as well liquidate all my savings [and] put it into hundred dollar bills, and stick it in the closet for my emergencies. (I do not carry a hundred dollar bills in my closet! Just please! Don't come rob me.)
Stitzel: We'll put Dr. Mattson’s address in the in the show comments here.
Mattson: [laughing] Yeah. Or I can put it all into equities. You know, money market mutual funds have been a really interesting place to go these days. You've lowered interest rates on all the boring vanilla stuff --all the stuff that's been the most secure -- to the point where, why bother with it? Why not just hold cash? And on top of that, because and going to this, you know, holding cash thing, (and one of the things that really strikes me with your question on this is) have they made these businesses worse off because of low interest in risk seeking? I think there's something to be added there. Because if you go back to about ’82, ’83, ‘84 (where we had, you know, kind of the top of these high interest rates), and you compare The Federal Funds Rate to something a measure of inequality (like the [Kendall] Tau Coefficient or the Gini Coefficient), [then] you're going to find that inequality in the U.S. has been rising very regularly as the interest rates have been falling. Now granted, there's probably some spurious correlation there. I'm not going to say this is a big econometric analysis…
Stitzel: But there is a mechanism…
Mattson: …there is a correlation.
Stitzel: But I would say there is a mechanism, not just a correlation. It would be one thing if it were just correlated, but there's a literal mechanism by which that would occur.
Mattson: So if we continue to lower interest rates, and it's the big banks that are getting most of the benefit of this, this shuts down the small to medium-sized banks say in a community like Amarillo. Now I know we have we have great banks here (and we all love Amarillo National Bank and Happy State and you know, First Bank Southwest). These guys do great jobs, and we love them, but they're at a disadvantage compared to Citigroup [and] Bank of America. And so, with the lowered interest rates, they are/they’re going to be less able to get a profitable return from, your again, vanilla boring lending. And so, they're going to lower that lending. They're going to have an incentive to play like the big banks in the shadow banking system (not necessarily lending to, you know, Bob's Leather Manufacturing Outlets, or something like that). And so then you have this potential for income to be lowering among the mid to low tier households as well, because those firms are suffering, their employees are suffering [and] the people that help supply that firm are suffering. So I do see actually, in terms of the private sector, this link between this consistent low interest rates, and this increase in inequality that we're seeing. I know the Gini Coefficient [and Kendall] Tau Coefficient measure income. But I think we can say the same thing about the firms -- that small businesses -- because small and medium banks are being hurt by this -- that they're gonna hurt, and that hurt passes on to their employees, [and] their customers and things like that.
Stitzel: So the intuition there is that the wealth inequality would be the first place you'd see it?
Mattson: Hmm (Agrees).
Stitzel: Because you're talking about income inequality, those two things are related…
Mattson: Sure. Sure.
Stitzel:…obviously and probably a little bit of a topic for another time.
Mattson: Hmm (Agrees).
Stitzel: Can you just comment on that very briefly: just whether you think that you're actually going to see that more on the wealth and equality side, than the income?
Mattson: I think you would still see it in the wealth side of it as well. Just very, you know, again very quickly, I had my Money & Banking Class do this – and take a look at the, first of all, bank concentration of small to big banks since 1990. In 1990 there used to be 30 small banks in the U.S. (small being: I think less than, I can’t remember the definition but it's definitely less than, I don't know, something like 500 million dollars). It's a big number. But 30 of the small banks to the number of the big banks, that ratio has been consistently going down since 1990, even into 2018-2019.
Stitzel: So you said 1990 it's around 30?
Mattson: 1990, so it’s now…
Stitzel: So what's it around today?
Mattson:…so it's now around probably six banks. Six small banks to every big bank.
Stitzel: And so that's just a straight drop, you know?
Mattson: It’s straight, yeah. Straight, consistent….
Stitzel: There’s no cycling there…
Mattson: Yeah.
Stitzel: It’s just free-falling.
Mattson: It's just, we've had this, and again this lines up with The Federal Reserve policy of lowering and lowering interest rates since the Greenspan era even. We've gone through 3-4 Fed chairs with this.
Stitzel: So you mentioned the profitability of small banks in particular.
Mattson: Hmm (Agrees).
Stitzel: Can you comment on the potential profitability of banks being at risk because of interest rates being held so long low for so long?
Stitzel: Or maybe even…
Mattson: Yeah.
Stitzel:…interest rates being negative?
Mattson: So, this is something that they really hit on in their article, and I like their approach to it. The thing that I have to disagree with them on (which you know they may end up being more right than I am) -- but in terms of looking at the European data, they were saying that bank profitability was going down with low interest rates, which I agree with, yes absolutely -- [but] I think if you separate out the big banks versus the little banks, [then] you're going to find that profitability for the big banks stays about the same if not increases. Because again, they're capturing more market share. And not only that, with the low interest rates, they're the ones. So if Amarillo National Bank starts playing in in the repurchase agreement market, and you know, dealing with some of the stuff that that Lehman was doing --I guess I should say Goldman Sachs because Lehman didn't get the bail out either, all right --[and] so Amarillo National Bank does stuff with asset-backed securities and the shadow banking system, and [then] they mess up, they're out, right? I mean they're going under. The Federal Reserve is not jumping in to save Amarillo National Bank because it's not such a big bank that is a systematic threat to the economy. Goldman Sachs, on the other hand, if they go back into the asset-backed security markets and they mess up, [then] they're getting the bailout. So all of those losses that they should have been facing, [and] maybe we should have carved up Goldman and sold them off too, you know, places like Happy State and Amarillo National Bank.
Stitzel: Yeah.
Mattson: Goldman, CitiBank, [and] Bank of America: they all have that implicit bailout guarantee that, you know, since they're so big The Fed and the [U.S.] Federal Government are going to protect them.
Stitzel: And that's time inconsistency?
Mattson: And that's time inconsistency right there.
BANK BAILOUTS: SIDE DISCUSSION
Stitzel: Yeah, so just as a small aside, because the thought that went through my head is: if Amarillo National Bank, Happy State, etc. here in town don't have that same kind of bailout safety net waiting for them…
Mattson: Hmm (Agrees).
Stitzel…they're not going to behave in such a way to seek that kind of risk.
Mattson: Right.
Stitzel: If I'm the type of consumer who's worried about the consequences of that kind of thing, [then] does that make me want to go with them, or want to go with the big guys that are potentially going to be bailed out?
Mattson: So I mean, for us mere mortals, you know, we're guaranteed up to what? $250,000 I think.
Stitzel: Yeah.
Mattson: If our bank goes…
Stitzel: you're talking about deposit…
Mattson:…deposit insurance, yeah. But if I'm a larger institution that is looking, you know, to deal with more than $250,000 and accounts back and forth, [then] I think that there is very much an advantage to go with a bank (that you know when you know the crisis hits and the global pandemic hits), [that] you know they're still going to be afloat because you can get your money quickly. And especially in a crisis, you want to get that money quickly, you know. And that's what leads to bank runs, right? And, you know, which we all think is a thing of the 1930s; but, we all forget, you know, it's the vast majority of bank runs during The Great Recession [since] we're all online.
Stitzel: Yes
Mattson: So you don't see them, but they exist.
Stitzel: They don't feel the same as (what's the movie?) It's a Wonderful Life, right?
Mattson: Yeah.
Stitzel: It doesn’t feel the same as that.
Mattson: But that was a great scene though, right? Jimmy Stewart, man that was a great scene!
Stitzel: Classic, right? And yet there are some economists that have been argued there have been bank runs but it's related to the interconnectivity of banks. So banks almost run on each other?
Mattson: Yes. Yes.
TIME INCONSISTENCY
Stitzel: So, okay I'm going to leave that aside, because I don't want to get us derailed too much.
Mattson: Oh yeah.
Stitzel: So we've talked about the profitability of banks. And we've set all this up through these low interest rates [and] negative interest rates.
Mattson: Hmm (Agrees).
Stitzel: What do you see as the effect of low interest rates on savers? And what do you see as the effect of low interest rates on banks?
Mattson: All right. So savers, and this is gonna you know, everyone's talking about [that] you're going to the grocery store these days, and they're telling you that, you know, they're not gonna be able to give you change, right? We're hoarding the penny now, right? The penny was, you know, much loathed [and] there were all these papers being written about [it] (actually, I think Dr. Kingsley had a paper on the penny, who you interviewed him a few weeks ago).
Stitzel: Yeah.
Mattson: [Now] the much loathed penny is now back in fashion. Low interest rates mean people are going to hoard cash, or at least hoard the most liquid assets they can. And okay so, you know, for a household that doesn't seem like much. But then if you start thinking that corporations like Google, Apple [etc., are] they're going to hoard cash, so that their payroll can be made every quarter; [then] that starts turning into a big chunk of change. So savers are going to start hoarding, because why bother (and liquid assets I should say)? Why bother hoarding treasury bonds, when you know you're going to get the same return? Zero!
Stitzel: [Repeats] Zero.
Mattson: Why bother going into the stock market because the stock market can crash? So that cash that you have is going to hold its value. I think because we've digitized so much of our currency now, it's not showing up as such a huge deal. But that's the behavior that people are going to go to is hoarding of the liquid assets. And that's at least the general thing we see, kind of on top of that, and I always love this this topic. The hundred dollar bill, for example, is the most common currency out there. But I don't carry around hundreds. I'm assuming you don't carry around hundreds.
Stitzel: No, no hundreds in my wallet.
Mattson: They're all in people's houses sitting just in case, right?
Stitzel: Hmm (Agrees).
Mattson: You got your rainy day fund.
Stitzel: So when you're saying Google is holding cash, [do] you mean literal cash?
Mattson: Literal cash [and] demand deposits.
Stitzel: [Repeats] Demand deposits.
Mattson: Yeah. Yeah. As liquid as possible.
Stitzel: So this cash shortage/coin shortage that we're seeing these days: that is a symptom of or direct cause of literally there being fewer people depositing money in their local banks?
Mattson: That's the symptom of it. Yeah.
Stitzel: And so what's the impact of this (I don't know the exact term) but this decrease in deposits that are going into banks? I just can't imagine that being good for banks.
Mattson: I don't know. Again, we've digitized so much, that, you know, if there is say I can't see a run on currency like [the film] It's A Wonderful Life, but I can see people pulling stuff out electronically. And on one hand, you know, it does sound more stable to me. On the other hand, I can't really see when it's happening, so that worries me a bit. I'm not sure how well it can be measured. I'm sure it can be. And I wouldn't be sure the numbers of it. But I think that's, you know, this leads that whole macroeconomic issue of, you know, your consumption is someone else's income, right? The hoarding of all of this money is the freezing of these liquid assets, right? And people aren't going out and spending. There's a huge aggregate demand shock going around. It's…
Stitzel: So I don't want to derail you…
Mattson: No, no, no. Go ahead.
Stitzel: Something just popped to mind.
Mattson: Go right ahead.
Stitzel: So as you might imagine, when the pandemic hits, and all of this happens, of course the first thing that a group of economists like you and me [and] our colleagues are going to do is run around making predictions/making arguments about things, right? One of these arguments is: is this an aggregate supply shock or an aggregate demand shock? And one of the things (I think I'm even on record saying this with an episode with Dr. [Rex] Pjesky), you know, saying the real problem with these kind of things is the reduction in economic activity -- the coordination and the connection between people. You've been from day one saying this is aggregate demand, guys.
Mattson: Yes.
Stitzel: This is aggregate demand.
Mattson: Yes.
Stitzel: Is this kind of thing that we're seeing, you know, the hoarding of liquid assets that's happening, because you're not taking those things and selling them (I'm sorry, not selling them)? But you're not taking this currency/this money and (making the kind of purchases) economic activity engaging in that like you normally would? I'm going to offer you the chance here to take a victory lap. Because it seems like any of your colleagues that said aggregate supply probably need to check themselves. Because it's some pretty strong evidence that it's an aggregate demand side.
Mattson: It is. And it's been an aggregate demand shock. And this also, you know, the article comes back to: one of the long-term issues of or short-term issues of lending, and whether or not lowering the interest rates will increase lending, and some a lot of this lending may be risky lending, and they start talking about zombie corporations. Let me just treat all lending as equal, and say lending is lending. We don't care. We want them to lend. If you pull up the commercial industrial loan data for the U.S, you see the huge spike in lending in 2020. So banks are lending out more than they ever have before, at a faster pace than they ever have before, [and] in the past five months than in any other period of our history. You know, even faster than the 2005-2006 build-up to The Great Recession. At the same time, we were going down with excess reserves, so banks were feeling a little better and pushing out those excess reserves to, you know, as part of their increase in lending before the pandemic. But once the pandemic hit, we went from about 1.6 trillion in banks holding excess reserves (so think of that as 1.6 trillion cash that's not being spent or loaned out in the economy) -- in a few months we went from 1.6 trillion to let me just let you see my graph here --- [to] about 3.2 trillion at the height.
Stitzel: Okay, so let's set this up historically.
Mattson: Yeah. Yeah.
Stitzel: Historically banks hold in excess reserves no more than you make them?
Mattson: Yeah. Yeah.
Stitzel: Right? You're required…
Mattson: That's the required reserve. Yeah, the excess reserves is whatever they hold…
Stitzel: Above that?
Mattson: Above that. Which is a terrible idea, because they could be lending it out and gaining interest from it.
Stitzel: Now that's a hot take isn't it?
Mattson: It is a hot take, yeah. Yeah but since 2009, we've gone from, you know, almost zero excess reserves to trillion dollar excess reserves.
Stitzel: So in the wake of the crisis…
Mattson: Yeah.
Stitzel:…in the response to the crisis, all these inflation fears abound; and they never develop, in part because they're being held in excess reserves?
Mattson: Yeah, we're holding trillions in excess reserves.
Stitzel: So to me, this is like the most important story that never got told. Somehow, and we just woke up and discovered it in, you know, 2015 or whenever. And then now we see, okay that excess reserves were tapering off, economic activity is going back towards normal, [and] banks were lending it out?
Mattson: Yep.
Stitzel: And now all of a sudden gigantic spike excess reserves are: would you say double or triple their height?
Mattson: I think it was double their height from the beginning of 2020.
Stitzel: Okay so now we've set that up so now tell us the story you were going to tell us.
Mattson: So we have this lending spike from banks. So on one hand, you can say that banks are lending more than they ever have before, at a faster rate they ever have before. And then we have an excess reserve spike. So at the same time, we're saying banks are not lending enough, which is the weird thing.
Stitzel: Well.
Mattson: Especially, yeah, how is that compatible? So banks are holding back potentially trillions of dollars that they could be lending out right now to try and stimulate the economy. Part of it is, you know, maybe in the wake of The Great Recession we can't find good lender or a good borrower still. You know, maybe there's still this issue of credit risk based on 10 years ago, you know, you and I are within the millennial generation. I guess we we've had to go through this. Our credit is just terrible, thank you 2009. But the other thing that needs to be considered is that also, you know, in 2008 that's when they started offering interest on these excess reserves. So now the banks have a decision themselves to make in the face of low interest rates. If they lend out at such a low rate, which is determined by The Federal Funds Rate, and you know, then the bond markets and things like that, then they open themselves to potential risk for a very, very low return on that lending. Or they keep the excess reserves on which, you know, just before the pandemic, they were earning 1.5 percent on holding those excess reserves. Now they're earning of course back down to 0.25 percent, but 0.25 is better than zero, and better than negative. So if lending is if profitability and lending is taking a hit, then they're going to only lend out what they are absolutely guaranteed to be able to get back. Within the paycheck protection program, the PPP loans that are going out that The Federal Reserve is basically guaranteeing, saying just lend, do it.
Stitzel: So yeah, so one of the consequences of low and negative interest rates is this search for risk seeking in order to try to get some return on your assets, right?
Stitzel: And now we're talking about the sort of other consequence where your instinctual response to a pandemic caused financial crisis-recession is to lower interest rates. But you're saying there are also these other effects where that's causing people to pull their money out and stick it in their sock drawer?
Mattson: Yes.
Stitzel: And that's why 100 dollar bills are and coins are vaporizing right now?
Mattson: Yep.
Stitzel: And so that’s sort of a double edged sword in that sense. So we think about these. And of course, I think (in my mind) the most important one is: you've created these bad incentives towards risky behavior to try to find some yield?
Mattson: Yeah. I want to respond to that. And give me a second to kind of think about it. But we've created these bad incentives. It's weird, because we think we're creating this good incentive. We're trying to get banks to lend. And that's supposed to be good, right now, right? In a crisis that's what The Keynesian playbook, that's what you need.
Stitzel: Right.
Mattson: And then, you know, you're also right, because we are creating these bad incentives here. Because, you know, people are moving towards risky behavior that they may not understand is risky. If I can't get interest on my bank account, I'm going to start playing the stock market. And the stock market is significantly more risky than my nice vanilla boring savings account. So that, you know, whether I'm realizing I may be completely rational in all other decisions -- and look at this -- and because I'm not pricing the risk correctly, because we've now taken this interest rate signal and driven it to zero --- no information almost….
Stitzel: Yes.
Mattson: No information.
Stitzel: That's right.
Mattson: Now we're going to get into negative territory probably.
Stitzel: What does that mean, right? That’s very difficult to parse.
Mattson: This is going to be, you're going to be incentivizing people who are normally very good at making these decisions to make bad decisions (or, and see I'm doing it again now with good and bad). You're incentivizing people to make riskier decisions without them fully understanding how risky they are. And that's true for the households. It's true for firms and businesses. And it's even doubly true for banks.
Stitzel: So in the paper that we're sort of riffing off of…
Mattson: Yeah.
Stitzel: They make the claim, you know, that European Central Bank tries to adopt these measures to mitigate the effects of negative interest rates, right?
Mattson: Hmm (Agrees).
Stitzel: To try to offset that risk seeking and to give some incentives towards better behavior in that sense, and still employing forward guidance about continuing negative interest rates. So they're saying, well we're still going to have negative interest rates, but here are some various incentives. And I don't want to get too much into what those are. If you want to talk about what similar things might be in the U.S., I'd like to hear that.
Mattson: Hmm (Agrees).
Stitzel: My point and probably the thing that stood out to me most about this paper is: I would like to make the point to any of the listeners that taking steps to mitigate unintended consequences and bad incentives that you've put in place from a policy is not the same thing as not inducing those consequences and incentives in the first place. So can you comment for a little bit about what type of policies we've seen in the U.S. to try to mitigate the negative effects of low and negative interest rates and how that might play out in the U.S.?
Mattson: Okay so I'm going to say none. In fact, we have what is, and what has been developed over many, many years of policy, of potentially making these financial imbalances and volatility worse. So if we think about it this way: what if we go into negative interest rates? And that makes (I mean maybe we may not feel specifically our negative interest rates, but) the bank itself will feel it on say the negative interest rate on their excess reserves. And so they'll start lending out a bit more, maybe taking more risks, [and so] that creates a financial instability within the banking system. But still, on top of that, with the very, very low return we're getting (and then if we have the short term rates going down the long term rates are going to follow at some point) that means (that if I'm you know if you and I are thinking about our retirement) we put that into a 401k or an IRA. And then where do they put that? They take that to equities. They put that in the equity markets. If anything, we have a (and don't get me wrong, I love my retirement plan, and I love not, you know, paying taxes on what I deposit until much later, great fantastic), but I have a tax incentive to push more and more of my assets into that account. Because honestly, that's the only place I'm getting any kind of return. That's the only place I'm getting any kind of store of value for my future consumption, and retirement, and things like that. So I think that actually no we're not mitigating any of the potential issues of negative interest rates. In fact, I think that what we have set up, which normally speaking makes a lot of sense. We want people to save for retirement. We want people to, you know, have confidence in jumping into certain equity markets. Yeah sure. But that encouragement of it, I think, is going to exacerbate the fallout when we start seeing some of the unintended consequences of negative interest rates.
Stitzel: So the tax policy dovetails with the low interest rates? If I want to get any return, I need to go into equities?
Mattson: Yeah.
Stitzel: Plus, I also have this tax incentive…
Mattson: Yeah.
Stitzel:…to put it into equity? So those interplay. That's a good point. I that hadn't occurred to me until you said that. So how do you take into account financial imbalances and fragility of your market (your financial markets) into account if you're not mitigating any of that risk?
Mattson: The traditional answer would be through some form of regulation, some form of deposit insurance (but now I'm getting into regulating the stock market, which I don't think people want but that) would be the traditional path of doing it. If going into some of these other markets [i.e.], going into the shadow banking system, and starting to measure, and regulate, and ensure what's going on [then], of course, if you have something like a global pandemic, the insurance companies are also going to be in big trouble as it is.
Stitzel: You beat me to my point. I was about to say: if you regulate the stock market, we're all going to the shadow banking sector.
Mattson: Yep. Yep. Yep.
Stitzel: But you anticipated that well. So this is this is what I meant when I said: mitigating the effects of these things is not the same thing as not causing them in the first place, right?
Mattson: Right. Right.
Stitzel: So now you're painting this picture where we regulate more at every turn.
Stitzel: We hold interest rates lower and lower and lower. We try to increase liquidity and people respond by engaging in riskier and riskier investments. And so now you've got a system where we're patching all the holes, and when it inevitably breaks you have a gigantic crash?
Mattson: Yeah.
Stitzel: as opposed to…
Mattson: to 2008-2009.
Stitzel: Exactly. And this one will be worse, if what you're telling me when you started off in terms of regulation didn't actually decrease leverage?
Mattson: I hope not.
Stitzel: Oh, but I mean if you're saying leverage hasn't actually been decreased, but regulation has been increased, and now we're forcing people into riskier, riskier propositions?
Mattson: Let me hedge my reputation for the comments section here [that] I maybe misspoke on. I'm not sure that leverage has increased, and I'm not sure that it has decreased only a little. All I know for sure is, so okay, so we're not 30:1, but I don't know what's going on in the shadow banking system, and I don't know how leveraged they are. And neither does anybody else. Who knows?
Stitzel: So my point is, my point is.
Mattson: Yeah. Yeah. I’m paranoid.
Stitzel: So my overall point is this: now you've gone to a system of - we create bad incentives and unintended consequences risks (I'm sorry -- yield search) that engage in increasingly risky behavior investments that are going to places that we can't monitor and see them (not that I'm proposing that we need like a top-down monitoring here); but, I just mean that understanding that you were talking about.
Mattson: That would be the approach.
Stitzel: I understand the risks that I'm taking when I go, right yeah, like that's the kind of behavior that we want to encourage. You're building a system that hopefully is harder and harder to fall apart. But the consequence is, when it does fall apart you have an enormous collapse.
Mattson: Hmm (Agrees).
Stitzel: You have, you know, just a completely out of control crash. And so, I think I'm concerned. Now you've said -- does the stability of the financial system decrease with negative interest rates -- you don't think so, or you're not sure, I guess. That's been the academic literature as well, right?
Mattson: Hmm (Agrees).
Stitzel: Is that’s the evidence is very mixed on that front. Do we see the stability of the financial system go down as interest rates are held low for a long time? The answer is: we really don't know.
Mattson: Hmm (Agrees).
Stitzel: There's mixed evidence. You can probably convince yourself either way.
Mattson: Yeah.
Stitzel: Honestly, my point is, by saying every time we turn around we say regulation is the solution here.
Mattson: Hmm (Agrees).
Stitzel: What I'm saying is: you're trying to build a gigantic interconnected system, and then we're going to try to patch all the holes and keep it from collapsing. My, what I'm saying is the consequence of that is when the crash comes it's going to be unparalleled.
Mattson: Right.
Stitzel: And no, I think there are good counter arguments to that. So if you want to raise them, I'd be happy to hear them. But my concern is: where's the understanding from the policy-making side that mitigating effects is not the same as not causing them in the first place?
Mattson: I think the structure that we are currently building in finance is looking more and more to me like the attempts that were made in terms of prohibition of alcohol, or regulation of gambling. It's risky behavior, but if you outright ban it, [then] people are going to find some way around it. And the cost may not be monetary, but then there's this cost of: increased chance of being arrested, increased chance of dealing with unsavory characters, increased chance of, you know, addictions and problems and other things that come with it that you're not pricing into it. Whereas, if you just have, you know, a grocery store that sells beer and wine, [then] they walk in -- like [if] it costs this much, [then] I will buy this amount, and I will leave, and then that price has a nice signal to it. The issue with regulation is that we make a choice each time we regulate more and more. When we put in the FDIC in The Federal Reserve back in the early 20th century/late 19th century, when those things were put in, the idea was: okay, we don't like these panics [and] we don't like this instability. Let's create a safe haven. Let's create some area people can go. (And also let's create Las Vegas. You can go and gamble there. And it's sort of the opposite of Vegas). I guess you can go, and you can be boring and vanilla, and it's the banking system and you can, you know, save.
Stitzel: And so your prohibition analogy is to say: not that we literally run into unsavory characters, but that our investments trend away from the grocery store environment to the backroom deal environment, okay?
Mattson: Yeah, Yeah. Are…
Stitzel: And there, by the way, you're not saying, or at least I don't think you are: I don't think there's any problem with saying that's how people will behave.
Mattson: Oh Yeah. Yeah.
Stitzel: The motivation for people is: I would like to one day retire, have something to live off of…
Mattson: Exactly.
Stitzel:…in my old age when I can't/don't have the same kind of earning capacity I do now, or something to pass on to my kids, or a dream that I want to build towards. So, these are not people that have some kind of unsavory appetite towards drinking and gambling…
Mattson: No.
Stitzel:…and those are the same motivations. It's very normal motivation…
Mattson: Yes.
Stitzel:…to want to save money and build your little nest egg. You have it. I have it. All the listeners have it.
Mattson: You’re going to want to have a safe place for it. And then, but at the same time, as a society you're going to want some place where people can take those risks. You want a shadow banking system. You want an equities market. These things are not in and of themselves necessarily bad, and regulation will not necessarily fix them. The issue with continually expanding regulation is whether or not we want to trade some of the benefit we get, from all of those say, asset-backed securities/stocks, things like that. Do we want to trade that benefit of, you know, the increased interest rates and returns that we get for stability and lower returns? Do we want to turn them into a regular banking system? And, you know, I would say you don't have to do that, but let's just make sure it doesn't go so crazy. But part of it going crazy has been this issue where we've now driven interest rates to zero for depositors.
Stitzel: Yes.
Mattson: You know, your savings account does not keep up with inflation.
Stitzel: But this is us trying to create the safe and vanilla thing. And yet, and the feel of the entire environment is that we're actually in a less safe, (we're in a crazier) more systemic risk rather than individualized risk. So the other thing that I really want to talk about…
Mattson: Sure. Sure.
Stitzel: And I think we've set it up nicely is what are the we've talked about how you create bad incentives, and you create this situation where people are responding to negative interest rates in a rational way that causes there to be more risk in the system.
Mattson: Hmm (Agrees).
Stitzel: So I think the idea is we use easy money to put that liquidity that we need in times of turmoil, or even pandemics…
Mattson: Hmm (Agrees).
Stitzel: And that, sort of, has an important, or potentially important role. But keeping interest rates too low for too long, not only do they create the kind of problems we've already discussed, but they create long-term structural problems.
Mattson: Yes.
Stitzel: I've heard almost no discussion of that before.
Mattson: Hmm. (Agrees).
Stitzel: And so that's something that I'd really like for you and I to drill down on. The authors of the paper suggest four persistent problems, or four persistent problem areas…
Mattson: Yeah. Hmm. (Agrees).
Stitzel:…they call those debt traps, poor credit allocation, allocation of resources and productivity ,and the profitability of banks. So let's talk about those. Do you want to make a general comment? Or do you want to jump straight to talking about this debt trap?
Mattson: You know, I want to hit the debt trap, because that was that was the part that really interested me when they were speaking in the article about there being an increased holdings of debt among European households as they're going into these negative interest rates. That now, if we/if you…
Stitzel: Ryan, let me let me stop you. I don't want to derail you, but just for our listeners at home: debt trap is like a very common term in economics. Define that really briefly for us, or at least how you're going to use it here.
Mattson: Oh at least how I'm going to use it here is: in terms of you're holding a whole lot more debt than you can pay off. So this is (I'm being a little loose with the definition here), but that's what I'm going to go for -- your debt is just really, really exceeding your potential income.
Stitzel: So what's the difference between being excessively leveraged and there being a debt trap?
Mattson: So the debt trap then, in that case -- is that you cannot -- it's you've got so much debt you can't even pay off the debt service. You can't pay off those interest rates. So the U.S., and there's the thing about low interest rates, because then if interest rates are zero, then debt service is really easy to pay.
Stitzel: Yeah.
Mattson: Then you're like, well shoot, why am I not taking out more loans? Or why am I not borrowing more?
Stitzel: So your simple vignette would be: if I went to the bank and they offered me literal zero percent interest rates, I'll take. I said, I'll take as much money as you have.
Mattson: Yeah. How much you got?
Stitzel: Yeah. Yeah. You’re a five hundred million dollar bank…
Mattson: Let me borrow. Let me borrow.
Stitzel: Let me borrow a million dollars.
Mattson: Right. So which you know, [what] they're saying is happening in households and governments across Europe, and I'll accept that (I haven't looked at the data). But again, it's a great article. I really like their conclusions. So I'm assuming that this is right. I really want to go in and check the data on that at some point. But when I checked it for the U.S., yes, federal debt [is] going up. We all know about our, you know, trillion dollar deficits these days, which man, you and I really need to get into a podcast about that at some point. But yeah.
Stitzel: It's on the docket. Some of the listeners at home know that we're going to have a debt episode coming. That is…
Mattson: There's a pressure.
Stitzel:...a popular topic among economists, but I think…
Mattson: Yeah.
Stitzel:…a much, much more popular topic among non-economists.
Mattson: See, and now we've said it. So to be time consistent…
Stitzel: Yes.
Mattson:…we have to like actually do this.
Stitzel: So, we'll discover if this is a time inconsistent or time consistent policy that I am offering on this podcast.
Mattson: So I want to say…
Stitzel: So we've set up what a debt trap is.
Mattson: Hmm (Agrees).
Stitzel: You've talked about this idea [about] European households. They kind of have this large accumulation of debt burden.
Mattson: Hmm (Agrees).
Stitzel: So the authors are worried, you know, households and governments accumulate these large debt burdens in the run-up to the crisis. And they continue to do that. And now you're going to run into a problem.
Mattson: Yeah.
Stitzel: I presume if we ever potentially try to unravel the situation that we've got into.
Mattson: Yeah.
Stitzel: Is that what we mean by this scenario?
Mattson:…yeah, yeah, I mean people will go bankrupt, right, and walk away from the debt.
Stitzel: Okay.
Mattson: So that's…
Stitzel: So tell us, tell us the U.S story.
Mattson:…yeah, so U.S. story is: yes obviously, [U.S.] Federal Government debt has gone up. We're now at 108-109 percent Debt to GDP ratio.
Stitzel: So our heuristic is probably less than 100 of GDP would be a great number?
Mattson: Yeah. Yeah, I'll settle for that. I'll settle for less than a hundred. I remember back in the early aughts [decade from 2000-2009] being kind of scandalized. That's what there was. Oh my gosh, we were at sixty percent Debt to GDP. Oh how naive I was.
Stitzel: So there's your teaser for a debt episode on the podcast.
Mattson: So, the household debt, though the debt that's held by households across the United States, at its generally highest, the ratio was about a hundred percent in 2008-2009. That's gone down to 76 percent.
Stitzel: How's that possible?
Mattson: People are paying off their debts, and people are not borrowing as much. Or banks aren't lending as much. We also have…
Stitzel: So the banks tightened up to whom they lend to and that's what’s…
Mattson:…probably the banks tightened up to whom who they lended to (or who they loaned to excuse me). Consumers have been trying to find ways to get by without debt. I know again, I'll talk about, you know, the millennials, right? And this is strange to me. Because I/you always hear about: oh yeah, people are crippled by student debts. But overall -- the aggregate. I'm not doubting that we're crippled by student debt. Don't get me wrong. But overall, the aggregate's gone down.
Stitzel: I might doubt that. I don't know.
Mattson: I will, yeah, it's the…
Stitzel: I think that's what's nice about being an economist is you can step back and be it's a nice narrative crippling school debt.
Mattson: Yeah. Yeah.
Stitzel: I definitely have seen data on you know what education costs are doing. That seems like a really bad trend. It seems obvious that student loan debt would be doing that. I've not gone to FRED and see what those numbers look like. So I don't know. We're agnostic here at the EconBuff about what school debt is at this point.
Mattson:…from a macroeconomic perspective, actually households have been paying off their debt. And they've been doing it consistently since 2009. And it's become at least a much lower figure than it was. And then to top all of that off, now remember I/we define this debt trap as being so onerous, so heavy that you couldn't even pay off the interest payments, right? I mean the debt service was also getting in the way of it. That's gone down too, as a percentage of disposable income. You know, again leading up to The Great Recession 2006-2007, household debt service payments as a percent of their personal disposable income was about 13 percent. So 13 percent of the budget household was spent on debt service, which was you know fairly high, but compared to the 80s and 90s, it was not hugely high. And now we're down to 9.5 percent in 2019.
Stitzel: So from what to what? Say that again.
Mattson: We've gone from 13-13.5 percent down to 9.5 percent.
Stitzel: That's a big drop.
Mattson: Which is a big drop for a macroeconomic figure, yeah. So what they're talking about in the article with European Union isn't really gelling with what's happening in the United States right now. And this is kind of strange. Because again, you turn on the news and you hear about all these issues with debt. Again I think that, you know, from the macro context, the big number is doing one thing. If we break it down, then I'd be willing to bet that, you know, low-income households are going into more and more debt. And high-income households are paying off more and more debt.
Stitzel: So that's…
Mattson: Yeah.
Stitzel:…we're right back around the wealth inequality then?
Mattson: Yeah.
Stitzel: So low interest rates exacerbate wealth inequality? That would be your intuition?
Mattson: Low interest rates exacerbate wealth and equality.
Stitzel: That which is actually something that they argue as well in the paper.
Mattson: Hmm (Agrees).
Stitzel: So you're definitely not alone on that. That's something I'm comfortable definitely putting out there. So let me kind of recap this.
Mattson: Yeah.
Stitzel: So potentially the problem is households/governments take on a huge bunch of debt because of the interest rates -- because interest rates are so low. That's intuitive. And then at some point, you need to unwind those low interest rates. And now your debt burden and your debt service is so high you can't possibly do that default, and you’re right back into a crisis?
Mattson: Right.
Stitzel: So you've not solved anything by low interest rates as a response to. Now you're saying households really don't show that trend? What about the government? Because I'm looking at the [U.S.] Federal Government and what? What was The Cares Act? It was like 20 percent of GDP that, you know, overnight that you've added to the debt?
Mattson: Yeah. Yeah. So, you know, there's the good news and the bad news of fiscal stimulus, right? I mean the good news is that: yay people get money [and] people spend money. That's grows the economy. You know, in a macro context, my spending is someone else's income. And they're gonna, you know, at some point pay taxes on that, and it'll all, you know, start to cycle back out. On the other hand, it's a huge amount of debt. It's a very large amount of money. That while it doesn't come out of thin air, the U.S. has got to borrow it from somewhere -- whether they borrow it from The Federal Reserve [or] whether they borrow it from the population of The United States. The biggest lenders to the U.S. government are [the] U.S. citizens and The Federal Reserve.
Stitzel: Well, we should make the point that doing it from The Federal Reserve, right, is monetizing your debt.
Mattson: Yeah, so you monetize the debt. And then at some point inflation's going to kick out.
Stitzel: Households are still paying that inflation, right?
Mattson: Yeah. Yeah.
Stitzel: And so we have [an] inflation puzzle.
Mattson: Yeah.
Stitzel: We won't get into that today. So my question is: there you can almost see like a moral hazard there, right? Where the government now has incentive to keep interest rates low because it can't service the debt?
Mattson: Yeah.
Stitzel: It's not quite moral hazard, right? Because it's probably in our best interest as well…
Mattson: Yeah.
Stitzel:…to not have the government collapse and default on all its debts, since that would be an unmitigated disaster?
Mattson: Right.
Stitzel: But at some point, instead of holding interest rates low, we probably need to unravel that?
Mattson: Yeah.
Stitzel: Is that how you see that?
Mattson: At some point because (and they bring up the issue -- that short-term thing of the yield curve management – of, you know, you're bringing the whole yield curve down), because you bring down the short-term interest rates for so long, [that] long-term rates are going to start coming down too. So at some point, all of that long-term investing is going to get no return as well. And the only way we can start to push that back up is: at some point let short-term interest rates go back up. Let short-term interest rates begin to rise again, and then the long-term will react to that.
Stitzel: So this ties in with our next idea then. This idea about poor credit allocation, right?
Mattson: Hmm (Agrees).
Stitzel: Where you have low and negative interest rates, and banks are looking for return and the consequence is: I need to go towards firms that are going to offer higher rates. Those are fundamentally going to be riskier propositions. Those are going to be riskier firms, ailing firms.
Mattson: Hmm (Agrees).
Stitzel: Now we're by having low interest rates, [and] we're encouraging capital to flow towards the poorest run firms, the riskiest firms, [and] the firms that are on the verge of dying.
Stitzel: What's the long-term consequence? What's the structural consequence of that?
Mattson: Well, you know, every factor of production, you know, whether you're talking about someone's labor, someone's human capital, someone's land assets, [or] technology; it should be allocated efficiently. You know, you don't want to be pouring money into a horse and buggy company when cars are beginning to rule the road. It's just…so now, what we have is all of this credit that could be going somewhere else. [It] could be going to a firm that actually produces something, or not one of these so-called zombie firms they mentioned [in the paper. And that the [RJ] Caballero Paper from 2008 [Zombie Lending and Depressed Restructuring in Japan] is actually a really interesting read. Now you have all of this money going into things that, and even if it is somewhat productive, but it's not as productive as it could be.
Mattson: Yeah, our listeners eyes glaze over when we say allocative efficiency.
Mattson: Yeah.
Stitzel: But that's really important. That's an idea. And, you know, as a teacher of economics, I haven't exactly sorted out: how do I convey this in in a way that gets my students as excited about the idea as it does me? But it's important, right?
Mattson: Yeah.
Stitzel: It's important that if we put resources in the hands of people who are using them poorly, [then] we're foregoing things that we could have benefited from. That's what the zombie firm idea is. I don't want to put…Sorry go ahead.
Mattson: Yeah, just kind of one last illustration if this helps. Have you ever seen the movie Margin Call [2011]? Kevin Spacey?
Stitzel: Recommended it to me several times.
Mattson: Probably by me several times. Yeah. There's a scene where one of these investment bankers, who's an older gentleman at that point, is talking about how in his younger days he was a civil engineer. And he built a bridge. And that bridge took people to and from work. And he, you know, sat down and he used his incredibly mathematical mind to calculate: how much time people saved [and] how much more of their life they were able to enjoy because he had built this bridge. And in that movie, the implication being -- what was he doing for the past 20 years of this investment bank where all of those assets are now going under? It was a Lehman type circumstance. What has he been doing with those 20 years? You know, getting paid probably a lot more money to move assets around (that may or may not be efficient) versus he could have been out there building bridges. So that's the most…it's kind of an on the nose little metaphor there.
Stitzel: It’s very messy.
Mattson: It really is an interesting scene. I'll send you a link to it.
Stitzel: But nothing's more important than opportunity cost and allocative efficiency, is just…
Mattson: I mean…
Stitzel:….opportunity cost and practice.
Mattson:…I think that banks, and hedge funds, and investment firms do great work. I'm not saying that is, you know, we should all be out building bridges. No there are/there's a place for moving around assets, making things more liquid, [and] providing that credit to people. But if the incentives of a bank are to provide credit to a firm that doesn't produce anything --- or some, you know, kind of a zombie company (or whatever they're calling it); if their money is going there instead of to, I don't know, a young tech firm that could be, you know, making the next social media hit or something, --- [then] it's wasteful. And that is one of the issues with this low interest rate, is again, you have these bad incentives. We're trying to push banks to lend, but we're not looking at why we want them to lend, or who we want them to lend to.
Stitzel: So this is the unintended consequence of negative interest rates. And, you know, creating this liquidity that doesn't have anywhere to go is: now you set up an economy that is very capitalist and resources are very poorly allocated. I don't want to put you on the spot, but…
Mattson: Yeah you do.
Stitzel: Yeah. Yeah, I kind of do. But this is the story of the lost decade in Japan. Can you briefly comment on what corollaries you see between where we're at now and maybe where Japan was at?
Mattson: Yeah.
Stitzel: For the listeners who are not aware, just give us two sentences about what the lost decade was in Japan.
Mattson: So the lost decade in Japan was, you know, in the ‘70s, and ‘80s, and the ‘90s. Everyone's telling them -- you teach their kids Japanese because they're, I mean, they're just, they're coming up on the U.S. so quickly. There was The Japanese [Economic] Miracle the ‘40s, ‘50s and ‘60s and the recovery. And then in the ‘90s they slowed down. And they slowed down a lot. And that's one of those things that, you know, you don't think about. Well, I guess they're a rich country. But having a large GDP doesn't necessarily make people better off. China has a huge GDP and will probably soon, if it isn't already, be the largest country in the world. Having a large GDP doesn't make your citizens well off. Growth and the ability of your citizens (and the people there) to expand, and earn, and develop, and have a comfortable life. It's the growth that matters! And Japan stopped growing. They tried all kinds of low interest rates -- zero interest rate policies that they're still doing right now. I believe they were one of the first central banks to dabble in equity markets. The government fiscally stimulated and continued to the point where I think the government Debt to GDP ratio of Japan is now, I want to say, somewhere around 200-250 percent.
Stitzel: Wow.
Mattson: So if you think that our Debt to GDP ratio looks, [then] bad take a look at Japan. Now they haven’t had…
Stitzel: Afraid our policy makers are looking at that and saying: well we can get to at least double.
Mattson: Oh yeah, what's the phrase? Hold my beer.
Stitzel: Yeah.
Mattson: Yeah. Yeah.
Stitzel: So that that should be…
Mattson: On one hand we have that. But, you know, The United States is a very large country at the same time. I mean, we've got 330 million people spread out over many geographic regions. Our economy is extremely diverse. It's, I see us slowing down, having a stagnation like The Lost Decade in Japan. At least, I would hope not, but then again, it was very much a lost decade after The Great Recession wasn't it?
Stitzel: Yeah. That’s scary.
Mattson: And they continued their zero interest rates. We've continued the zero interest rates. So it is, it is a similar situation. I don't know, maybe I'm too optimistic, but I hope we're not.
Stitzel: So is this is this the underlying idea of The Lost Decade, right? Is that you have unconventional monetary policy leads to things like poor credit allocation and bad allocation of resources and consequently low productivity?
Mattson: Hmm (Agrees).
Stitzel: The eventual outcome is: employment, investment, competition; they all suffer because inefficient firms aren't driven out of the market. You know, I think, I don't want to comment too much out of turn, you know. But I see, especially in economics but probably in a lot of areas in life, this sort of Federalization [Feditization by The Fed] of Safety and we don't want anybody failing. And we don't want anybody, right?
Stitzel: And it's like, which I don't really want to comment about that for individuals, but I will say it's not a great idea for businesses.
Mattson: Hmm (Agrees).
Stitzel: Some businesses need to close. And sometimes through no fault of their own…
Mattson: Sure. Sure.
Stitzel:…maybe society has just passed them by.
Mattson: That's why we have bankruptcy.
Stitzel: That’s why MySpace was a great idea.
Mattson: Yeah. Right. (Agrees).
Stitzel: And now we don't need MySpace, because we have (well we had) TikTok.
Mattson: That's why we have bankruptcy laws, right? The idea is that your business can fail. You can go bankrupt and still survive. You're not completely ruined, which I think was/is a really nice aspect of The American Financial System. I don't know though. I don't know how [or] that bankruptcy works internationally and/or in other countries.
Stitzel: So this is what I want to turn to as we bring this in for a landing. I think we've done a good job highlighting: negative interest rates have these bad incentives [and] they have bad unintended consequences. I think we've brought something to light, along with the authors of this paper, that have kind of inspired us about the structural problems that it presents. It's a really nice tight package. So now I want to turn to you, and get a ray of hope. How do we get away from negative interest rates?
Mattson: I would get…[pauses]. Can you be more specific on how do we get away from negative interest rates?
Stitzel: How do we, how do we end up in a situation where the solution to our recession are: The Next Decade?
Mattson: Right.
Stitzel: Hopefully we bounce back here like we did out of 2008. We get a nice bounce back in 2021, and that's the year we all hoped that 2020 would be.
Mattson: Okay.
Stitzel: And now we have a decade, and instead of that decade being extended low interest rates, which by the way, low interest rates were already a problem going into 2008, right?
Mattson: Hmm (Agrees).
Stitzel: That's how you get a bubble in the housing market in the first place.
Mattson: Yeah.
Stitzel: Right. So we're not talking about a problem that started in 2008.
Mattson: The days when three percent was low.
Stitzel: Right. We're starting/we have a problem that’s starting in like 2001.
Mattson. Yeah. Yeah.
Stitzel: So here we are 20 years later, basically paying the consequences of that. Where's the path that gets us to a situation where interest rates aren't so low, as to be causing the kind of problems that we've highlighted today?
Mattson: Yeah, so we don't. We don’t get away from those interest rates.
Stitzel: I wanted a ray of sunshine.
Mattson: There's no [ray of sunshine]. No, I can't do that, cause you say since 2001. If you look back at it, it's actually since/it's probably about 1984. This consistently lowering of interest rates over, (good lord, are we in our four…yeah we're getting to 40 years now) over about 40 years now. I see no incentive for The Federal Reserve to start raising interest rates. In fact, I see much more incentive for The Federal Reserve to continue non-traditional monetary policy, potentially even expanding it.
Stitzel: Why is that?
Mattson: Then we're not getting the bang for the buck. This recession, you know, is unprecedented. If you look at the amount of contraction that's going on, The Federal Reserve can continue to lower interest rates. That's great. But if they start raising interest rates, then people are going to be screaming bloody murder and saying -- oh you're trying to contract the economy at, you know, the height of this problem much in the same way, you know, The Fed was defending the gold standard in [the] 1920s/1930s; and they continued to defend the gold standard throughout the 1930s, leading to them contracting the money supply. And then you have Milton Friedman writing, you know, the condemnation of them in monetary history saying: okay, they didn't cause The Recession of 1929, but they sure extended it out for the next 10 years.
Stitzel: Hmm (Agrees).
Mattson: Their incentive right now is: to not do what they did in the 1930s. And they are going to stick to the Keynesian playbook. They're going to maintain low interest rates. They're going to continue to shoot liquidity into the economy as much as possible. And that's going to be, you know, soaked up by these excess reserves, soaked up by individuals hoarding, and we're not going to get out of this until aggregate demand recovers. And that's not something that over the long run The Federal Reserve can do. The short run: we have, you know, the monetary illusion. You can stimulate briefly, you know, 1-2 years and then get back to where we were. But we have been over 40 years when we hit each recession, we do monetary stimulus. Hey that works great. And then you're supposed to say: okay, now let's raise interest. Let's -- well not even -- let's raise it. Let interest rates go back up as -- people want, you know, more demand -- interest rates should be working like that. But that's not what The Federal Reserve wants to do. And the [U.S.] Federal Government owing so much to The Federal Reserve certainly doesn't want them to raise interest rates either. Because then that debt service payment is going to become pretty onerous onto The Treasury.
Stitzel: So my moral hazard argument from earlier is better than I than I thought it was.
Mattson: I know. I think that is something that we do need to start considering the fact that…
Stitzel: Thanks for that. I can sleep tonight now.
Mattson: Yeah. No, our [U.S.] Federal Government owes a whole lot of money to The Federal Reserve right now.
Stitzel: Yep.
Mattson: Which I guess, you know, people will like more than us owing a whole bunch to the Chinese government.
Stitzel: Yeah.
Mattson: Which I think is funny, because we actually don't owe that much. All right -- let's -- that's again, another podcast there with debt.
Stitzel: So the authors of this say: on one hand, the longer the exceptionally low rates remain…
Mattson: Yeah.
Stitzel:…the worse [it is for] the outlook for financial stability…
Mattson: Right.
Stitzel:…which we've established in spades today.
Mattson: Right.
Stitzel:…but on the other hand, raising rates would also cause problems for the banks. I'm going to let you have the last comment here to bring this podcast in for a close. What are your thoughts on that statement?
Mattson: So we are/we've been building up to this moment, in the zero lower bound since the 1980s, with how we have been playing with the money markets. And that has had some great benefits, but it also comes with some great costs. And to get out of these low interest rates -- and you get out of this kind of low interest rate problem or negative interest rate problem (that we're going to get into) -- we may have to sacrifice stability in the short run. And this is where someone is going to have to make a Volcker Decision. This is where some Fed chair, or Congress, or President is going to have to say that we can't do this anymore. We're going to start to let interest rates rise. And that didn't work out very well for Jimmy Carter. You know, 10, 15, 20 years later [it] worked but very well for Paul Volcker. I'm a hugely respected guy. His biography is fantastic, if I can plug that, very well-respected economist. He made an extremely unpopular decision to raise rates to tame inflation. And probably, I would say, within the next 5-10 years someone is going to have to make that decision again.
Stitzel: Again, my guest today has been Ryan Matson. Ryan, thank you for joining us on the EconBuff.
Mattson: Thank you very much.
Comments