Interfluidity: the negative unnatural rate of interest

From Interfludity:

David Andolfatto points out that US five-year real interest rates are now negative.....

When we observe negative real rates, they are often attributed to something abnormal. Perhaps it is “depression economics” which has driven interest rates underground....
I think this aberrationist view is quite wrong. I don’t think you can make sense of the last decade without understanding that the so-called real interest rate has been trying to fall through zero for years. Only tireless innovation by the men and women of Wall Street prevented negative rates long before the traumas of 2008. A deep cause of the financial crisis was a simple expectation: That lenders ought to earn a “decent” real, risk-free yield even while a variety of trends — skyrocketing incomes for the 0.1%, the professionalization of investing, leverage-induced risk aversion, China — were creating Ben Bernanke’s famous savings glut. The market response to a global savings glut ought to have been sharply negative real interest rates for low risk savers. But as a society, we resent and resist that capitalist outcome. It is well and good for markets to drive the price of undifferentiated labor asymptotically towards zero. But God forbid that “savers” not be paid for supplying a factor that turns out not to be scarce. Instead, an alphabet soup of financial innovations was conjured to transform bad lending into demand for low risk money, and thereby support its price.... There is no such thing as a “natural” anything in economics. Economic behavior is human artifact and artifice. When economists call anything “natural” — the natural rate of interest, or of unemployment — you should recall Joan Robinson’s famous quip:

The purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists.

... What was the “natural” real rate of interest in 2006? According to TIPS yields, 5-year real interest rates were about 2.5%. But those rates were observed under the institutional context of a structured finance boom which transformed a lot of loose lending into allegedly risk-free lending demand. Was that rate “artificial” then? Today those same rates are -1%. Is this “natural”?

Ultimately, the words are meaningless. The level of interest rates that prevails in the market will be the result of a mix of institutional choices and economic circumstances. For now, we are in a bit of a pickle, because if we are “conservative” — if we stick with familiar institutional arrangements — we end up with outcomes that are violently disagreeable to our cultural prejudices. In social terms, a negative real rate of interest means that prudence is a cost, not a virtue. Caution is a greater vice than spending what you have and hoping for the best. Savers must be punished for their thrift.

... Current spenders assume risks of future deprivation that current savers are unwilling to accept. Why shouldn’t spenders be paid to bear that burden? Transforming present resources into future wealth is uncertain and difficult work. Savers’ expectation of a positive real interest rate amounts to a demand for time travel cheaper-than-free. Why should such unreason be accommodated? The sense of entitlement carried by savers in our society would put any welfare queen to shame.
So, are negative real rates the way to go? Should we just tell savers exactly what we tell laborers? The price of the factor you supply has fallen. This is capitalism, quit whining and deal with it!
Maybe. But maybe not. In theory, a sufficiently negative rate of interest could restore a full employment, noninflationary equilibrium....
But it might not work out so well. Debt is a particular and problematic institution. If savers must pay borrowers for the privilege of carrying forward wealth, it matters in the real world whom they pay and how well those people do their jobs. Borrowers can always default, even after they have contracted loans at negative interest rates. If we try to restrict lending to only very creditworthy borrowers, we’ll find that real interest rates have to fall sharply negative to induce spending by people who would otherwise be inclined to save. If we allow more liberal credit standards, we’ll observe higher notional interest rates, but only as prelude to widespread defaults. We’ve seen that movie and it isn’t entertaining.

The post is worth reading in its entirety. Waldman goes on to suggest that "observed interest rates are a function of distributions and institutions as well as technology," and to sketch out a model in which the distribution of resources can push the real interest negative. He suggests that this is one possibility for what he believes is the long term effort of the interest rate to go negative: "in a sufficiently unequal society, the marginal saver may have vastly more wealth than is necessary to endow her own future consumption (including proximate bequests)."