January 2, 2013 at 3:25 pm #17485johnhenry07Member
First off, thank you very much for taking the time to answer these questions. Liberty Classroom has been a great resource, especially for us attending universities where we simply can’t get the Austrian perspective on these issues.
I was hoping to hear your take on the place of short-term rates in ABCT. Rothbard, in America’s Great Depression, wrote: “A firm may simply cease using its own funds for financing short-term inventory, and instead borrow the funds from the banks. The funds released by this borrowing can then be used to make long-term investments….All credit is interrelated on the market, and there is no way that the various types of credit can be hermetically sealed from each other.”
A Mises.org article ( http://mises.org/daily/4573#ref1 ) discusses the “expectation theory of the term structure,” which “basically says that if and when the central bank governs market agents’ expectations regarding the future path of short-term rates it actually determines the longer-term interest rate.” This is because “a long-term interest rate…is a weighted average of short-term interest rates expected over the maturity of the credit contract.”
You don’t have to address these quotes specifically, but I was wondering if I could get your take on whether artificially reduced short term rates indirectly stimulates long-term investments? This is of particular interest to me because I’m studying 19th century Britain where it was considered a disreputable practice for banks to remove funds from the circulating capital by sinking it into longer term investments, like mortgages (this isn’t to say all banks obliged). If this is too broad a topic to unpack in this forum, perhaps you could just provide some resources. Thank you very much!January 5, 2013 at 1:55 pm #17486jmherbenerModerator
When banks intermediate credit, they tend to match the time structure of their loans (assets) with the time structure of their borrowings (liabilities). Also, interest rates tend to rise across the time structure because of increased intensity of time preferences, i.e., shorter term loans have lower rates than longer term loans. Arbitrage by banks from shorter term borrowing to longer term lending would be possible if banks find a stable renewal by savers of some portion of their short term lending to banks. Doing so would flatten the yield curve make banks less liquid,. Both of these factors would eliminate the profitability of further such arbitraging.
With fiduciary media and credit creation under central banking, these restrains are relaxed. The central bank targets the federal funds rate (i.e., the interest rate banks pay to borrow reserves from other banks) by supplying banks with more (or less) reserves through larger (or smaller) purchases of bank assets. Banks must decide how to allocate the credit they create across the yield curve without the guidance of savers’ preferences. Whether they lend long or short term, their balance sheets will be illiquid, so that does not constrain them. Their liabilities (i.e., the fiduciary media) are instantaneous) while their assets (i.e., their loans) have time structures. If the central bank has policies that shield banks from the ill effects of their illiquidity (e.g., bailouts, deposit insurance, soft bank audits, and so on), then they will tend to allocate credit longer term to earn higher interest rates. Government policies shielding banks also lead them to reduce their equity.
You might take a look at the relevant articles by Guido Huelsmann:
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