Tuesday, 11 June 2013

Tight money is the new black

Tight money does not raise interest rates, at least over the relevant time frame for welfare considerations. Interest rates in the Euro zone today (0.5%) are almost certainly lower than they would have been had the ECB not adopted a tight money policy in 2011, raising rates from 0.75% to 1.25%. That policy drove the Euro zone deeper into recession, pushing rates even lower. The same thing happened in America in 1937-40.

Low rates can reflect tight money. Even low real rates. The low real rates in America today partly reflect the recent recession, which was caused by ultra-tight monetary policy in 2008-09.

Savers might also be helped by a lower rate of inflation. In practice, savers are hurt more by the drop in GDP [and real interest rates] associated with tight money, than they are helped by the lower inflation.

Thus the central bank should not help virtuous savers, nor should it try to help non-virtuous savers. But the tax authorities should help both groups, by eliminating all taxes on investment income.

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