Negative, zero or very low interest rates encourage people to buy much more expensive homes than they normally would, which is to their benefit until interest rates rise. Despite stagnant economies many European cities are experiencing a rapid rise in home prices largely because of low interest rate policies. This real estate bubble cannot be sustained, so at some point it is going to all come crashing down.
If governments can borrow at negative or close to zero interest rates and endlessly roll over their debts, it makes no sense to tax. Just borrow all of the money and get rid of the cost of complying with the tax code, the costs of tax collection by the government and, most importantly, the disincentives for work, saving and investment resulting from the tax system.
When students study basic finance, they learn that if the risk-adjusted rate of return on investment exceeds the cost of the money to finance the investment, the investment should be made, and vice-versa. For instance, if a fast food store owner’s analysis shows that the rate of return on an investment of opening a new store after inflation, taxes and adjusting for the likely risks is going to be 10 percent and he can borrow money at 3 percent, it makes sense to make the investment. The problem is that, in the real world, only governments and large or politically connected companies can borrow at the very low rates. Most smaller and entrepreneurial businesses and consumers have to pay far higher rates, because of the perceived additional risk and the cost of servicing the loans. Entrepreneurial businesses create most of the new jobs, but the monetary and regulatory policy bias against them reduces their ability to do so. The rate of new business growth has fallen in the United States but is still greater than that in Europe, where the negative and low interest fad has gone even further.
This post was published at David Stockmans Contra Corner on May 2, 2016.
Recent Comments