Home > Main > Renting Money and Borrowing Houses

Renting Money and Borrowing Houses

July 26, 2011

What’s the most obviously wrong idea in thinking about inflation?

I’d say the idea that inflation – any inflation – is a form of default on government loans.

Reinhart and Rogoff – two extremely influential economists – wrote a book that says the same thing: inflation is a form of default.  And they are wrong, very wrong.

Here is another smart guy being totally wrong:

 In the book This Time Is Different, Reinhart and Rogoff take a more expansive view of default.  So do I.  To them/me, massive inflation is a type of default.  Any means of paying off a debt burden by handing off something less valuable than what was received, plus interest, is a form of default.

Yes, the Zimbabwe option is available.  Print money with abandon, issue debts with abandon in your own currency.  Use what you get from that to finance your budget deficit.  That has been done, but it is a form of default.

I give no credibility to those who say a sovereign nation can always issue more debt in their own currency, particularly when there are large voting blocs in society that will oppose inflation, or the fear of higher taxes from additional indebtedness.

This is wrong thinking.  Aleph is wrong about inflation being a form of default.

Inflation isn’t a form of default.  This is because borrowing money is very similar to renting money. The transactions are nearly exactly the same. You’ll hear finance professionals talk about “renting money” because the ideas of borrowing and renting are so similar.

Any loan/borrowing agreement involves borrowing something today, and giving it back in the future.  If you have a loan/borrowing agreement with real world goods, you’ll borrow something and give it back in the future.

The term that most people associate with borrowing real world goods is “renting”.

Borrowing is the word we use instead of renting for transactions involving money. But the idea is still there – renting the use of something for a time, then giving it back, in exchange for compensation.

Let’s borrow something that isn’t money, and see if anyone would agree with his statement.  We will change one word, so “any means of paying off a rental burden by handing off something less valuable than what was received is a form of default.”

Many people borrow things other than money.  One of the major things people borrow other than money is real estate.  Renting real estate is borrowing real estate for a while, and giving it back in the future, in exchange for compensation.  We call it renting, but the idea is so close to borrowing that most people wouldn’t be able to tell me the difference in plain english.

The borrower will compensate the lender for wear and tear on the real property.  Of course, the borrower will compensate the lender for the utility of using the real estate.

But very, very few contracts would have an additional compensation paid from the lender to the borrower to insure that the real estate retains worth to other people beyond the normal wear and tear and destruction of the property.

For example, nobody would rent a building and agree to a clause in the contract that says if the value of the building goes down due to real estate market price action, the renter owes the landlord additional compensation.

If we apply the R&R logic on inflation to anything else but money, it becomes self-evidently wrong.

To be 100% clear, Reinhart and Rogoff propose every renter in the United States should compensate their landlords for any and all loss in value of the rental property. This is a simple application of their position on inflation to “borrowing” real estate.

Nobody calls out Reinhart, Rogoff and the rest for being obviously wrong.  It might be because money casts a spell over people so they can’t think straight.  In the end, it doesn’t matter.  Applying simple logic to their positions, it becomes obvious they are wrong.

Categories: Main
  1. July 26, 2011 at 10:13 am

    “The borrower will compensate the lender for wear and tear on the real property”

    In the UK only damage beyond normal wear and tear can be compensated in residential letting.

    Normal wear and tear is the landlord problem – which they need to cover in the charge they make for borrowing the property.

    Similarly with renting cars. You wouldn’t expect to have to provide the hirer with a brand new car at the end of your three year lease period.

    Arguably inflation is wear and tear on money. It needs to be worth less in the future than today as an incentive to spend it today on things.

  2. TC
    July 26, 2011 at 10:24 am

    I think this is the case in the U.S. as well for most leases.

    Inflation is a strange beast, but thinknig about it as wear and tear on money is a good frame. Nobody has any problems with real world goods wearing out and getting less valuable. Why should money have properties denied to real world goods?

  3. Paul Mineiro
    July 26, 2011 at 10:56 am

    I am pro-MMT. However I do not find your analogy compelling. The government is the monopoly supplier of currency. If the renter in your analogy could make more houses at will then it could certainly cause the market price action the property owner is worried about, which would change everything. Is it silly to rent a house when you can make it at will? About as silly as borrowing money you can manufacture at will to finance your operations. In both cases the point would be to regulate aggregate demand.

  4. July 26, 2011 at 11:00 am

    And procrastination is a form of depression, but the differences are huge.

    I too am amazed at the so-called “experts” view of our problems. I feel as though I’m living in an alternate universe.

    It’s like fighting the “earth is flat” argument over and over again.

    If it weren’t for my belief in the infallibility of simple arithmetic (when applied properly) I would be doubting my own views.

    Fortunately for me I’ve always been a skeptic.

  5. July 26, 2011 at 12:19 pm
  6. Tom Hickey
    July 26, 2011 at 12:47 pm

    The actual problem here is that R&R and many others see things in terms of the quantity theory and project inflation where there is no observable causal mechanism leading to it. This is the weakness of monetarist and debt theories in comparison with fiscal theories. Inflation is not absolute quantity but quantity relative to the relation between effective demand and the ability of supply to expand to meet it. It’s unobservable myth v. observable reality.

  7. Sergei
    July 26, 2011 at 1:19 pm

    Commercial banks default all around the world. They always and everywhere pay less than inflation on transaction accounts. And often pay less than inflation on standard savings account.

  8. Peter D
    July 26, 2011 at 11:51 pm

    I’ve been thinking of a reply to Sumner’s question
    and I just thought of the following:
    Why not create Tsys that pay only the inflation rate – almost like TIPS but without fixed rate component. Let those be the ONLY bonds issued. The savers then can always keep their spending power intact and not have to engage in Sumner’s “hot potato” dymanics. Essentially, this allows savers to remain savers, which MMT thinks would happen anyway, at least in most cases, but why even find out? There is also no IGBC since the rate on the bonds is always less than or equal the growth rate (even if growth is negative), so, such borrowing is “sustainable” indefinitely. The rate then becomes not zero, as in Mosler’s proposal, but the inflation rate. Everybody is happy!
    Is that not an amazing solution? Am I missing something?

    • Peter D
      July 27, 2011 at 12:59 am

      Actually, this is not exactly right- one could have negative growth and positive inflation but this is not a problem: the government still pays only “in real terms”.

      • July 27, 2011 at 1:33 am

        We have index linked gilts in the UK, which are used as the backing for pensions in payment mostly.

      • Tom Hickey
        July 27, 2011 at 8:50 am

        Indexing adds to inflation. I think that Warren’s proposal is the best yet, as usual — max 3 mo T-bills. Interest on tsys is a subsidy.

        • TC
          July 27, 2011 at 3:48 pm

          If the Warren’s idea that what the government pays sets the price level, then indexing will be inflationary.

    • beowulf
      July 27, 2011 at 10:07 am

      Ha ha, I’ve commented on that Sumner piece at both NC and Warren’s sites and I’ve yet to read it (I will say that . :o)

      Peter, I suppose “the natural REAL rate of interest is zero” is not the worst idea, but I think it’d better to use nominal 0 (if a govt stiffs you, I guess that rate is “absolute 0” but I digress) for T-bill but also improve the existing inflation-adjusted savings vehicles, TIPS of course and Savings I-bonds that pay out the rate of inflation . For some reason TreasuryDirect caps annual purchases of savings bonds to $5,000– $10,000 per couple (for now you can double down if you also buy paper I-bonds through a bank but Tsy is going all online in January).

      $10k seems a little low considering that the people who really need inflation-adjusted savings are retirees and they’d probably wish to make lump sum transfers. Of course what retirees REALLY need is for Tsy to provide low cost inflation-adjusted life annuities, something Dean Baker has suggested. Naturally, General Benjamin Butler suggested something similar 120 years ago (“terminal annuities”).

  9. July 27, 2011 at 4:59 am

    And deflation is a form of usury.

  10. Peter D
    July 27, 2011 at 7:06 pm

    OK, I understand that indexing ads to inflation, but as long as the propensity to consume out of the interest income is less than 1, the contribution from indexing goes to 0:
    if pi[i]=alpha*pi[i-1], where pi[i] is the inflation in period i and alpha is the contribution from previous period’s inflation resulting from the indexing, then pi[i]=alpha^i * pi[0] and this goes to 0 when alpha is less than 1.
    What I like better about this proposal than the 3 mo Tsys is that this simply allows savers to stay savers without sacrificing their spending power (up to one period adjustment.) With nominal rate = 0 or, similarly, with 3-mos Tsys or IOR several things can happen:
    (1) again, inflation can eat into savers’ savings
    (2) if the growth rate is less than the nominal rate, you get some sort of instability, not the stupid “predicable” one of IGBC, but something less clear. Why try?
    (3) the people may shift into unstable speculative activities if they are unsatisfied with the nominal rate.
    Setting real rate to 0 prevents most of that to a large extent, it seems to me.

  11. Peter D
    July 27, 2011 at 7:14 pm

    Sumner and Co have some interesting transmission mechanisms in mind when they talk about inflation. I guess if I studied economics not from the MMT blogs ( 🙂 ) I’d understand better what they are talking about and have all the necessary mental shortcuts. But my simple understanding of savers turning into spenders seems inadequate for what they are talking about. I still need to wrap my head around these things. As far as I could understand, they think increasing the monetary base should be inflationary, regardless whether done with debt monetization or with additional deficits (note, they, rightly in my opinion, don’t consider interest-paying reserves to be any different from govt bonds; so, replacing bonds with interest paying reserves is not really increasing the base.)

    • July 27, 2011 at 10:36 pm


      It generally relies upon a belief in full employment equilibrium and the inability of an economy to quantity expand.

      It probably also requires a downward sloping market demand curve. You could throw the cat amongst the pigeons and ask how their model deal with the “Sonnenschein-Mantel-Debreu” (SMD) conditions.

    • beowulf
      July 27, 2011 at 11:02 pm

      Peter, Then it sounds like we can all agree to agree— Since the Fed does now in fact pay interest on reserves, then expanding the mon– errr, “interest-paying reserves base” (wait, is “monetary” the taboo word or “base?) is something that isn’t inflationary because its no different than govt bonds.
      As for indexing, I think its a useful tool to help out those on the low end of the wage scale (who, almost by definition, have the least bargaining power). For example, it’d make sense to adjust minimum wage by CPI annually like Social Security benefits have been for decades. On the other hand, those with the greatest bargaining power should face taxation on outsized gross margins. Tsy would come out ahead even if it never collected a penny. That’s because firms in the crosshairs could minimize or avoid the tax by cutting prices (lower cost-push inflation) and expanding aggregate supply (higher potential GDP).

      The paper by Seißer proposes a profit tax, τ(q), equal to the Lerner index
      as a means of improving economic efficiency. Since the Lerner index, (price-
      marginal cost)/price, is generally decreasing in output, firms will have an
      incentive to increase output to reduce their profits tax and this can reduce
      the deadweight burden of monopoly.


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