Friday, May 29, 2015

Artificial Interest Rates, Artificial Wage Rates, and Jobs

Paul Krugman claims not to understand what people mean by "artificially low interest rate".  Let me try to explain.  

We usually think in terms of supply and demand curves and where they meet is the natural market price.  If the government forces some other price, that is an artificial price.

Imagine that the current demand for entry level unskilled labor and supply of such labor meet at $8 per hour.  Then imagine government forces the price to $15/hour.  Then the supply does not equal demand.   At $15/hour the supply of labor exceeds the demand.  There will be a shortage of jobs.     If the government of Venezuela forces the price of toilette paper below where the supply and demand meet, you get shortages of toilette paper.     This is simple micro-economics.

There are people who want to save money and people who want to borrow money.  These people make up the supply and demand curves for money.  The natural interest rate is the market price where these supply and demand curves meet.   If the government artificially sets the interest rate someplace else, bad things can happen.   They can force the interest rate down by having the central bank make new money and buy bonds.  Driving up the price of bonds lowers the interest rate.  The central bank is a government creation and so not really part of a free market.  What it does to the interest rate is artificial.

With central banks holding interest rates near 0%, and minimum wages going up, companies have huge artificial incentives to borrow money, buy robots, and replace people.  The monthly cost of a loan goes way down if the interest is near 0%.   When a company evaluates the choice of robot vs human, they compare the monthly cost of the labor to the monthly cost of the loan.    The artificially low interest makes the monthly cost for a robot much cheaper than it naturally would be.   Thus the distortion of the interest rates distorts the trade-off between labor and robots in favor of the robots.

It may be easier to think about with some concrete numbers.  Imagine the natural market interest rate is 8% but government has forced interest rates so low that companies can borrow at 2%.  This would mean the monthly interest paid on a robot loan is 1/4th as much as it would naturally be.   

The Keynesian economists theory is that forcing interest rates down mean companies can borrow money, build factories, and make jobs. The reality is the opposite. Low interest rates push companies to replace people with robots.

Forcing minimum wage up and interest rates down is great for robots, but not good for minimum wage earners, who may become unemployed.

On CNN they have an article titled, Robots will replace fast-food workers.

I think a free market would make new jobs as fast as technology made jobs obsolete.   I am not a Luddite.   But when the government artificially sets the interest rate and artificially sets the labor price, we are not in a free market.