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  1. Charles Loucks on


    I have an essay at: http://www.hvgreens.org/challenge/KfactorPaper.pdf . I am trying to get some feedback from professional economists on this. I am arguing that the standard formula used to calculate loan payments has a serious flaw that has the effect of placing an arbitrary brake on economic activity. I also argue that this effect can be overcome by using a different formula which I propose.

    What is the significance of this? Well, for one thing the monetarists argue that the economy works best when inflation is near zero. I’m arguing that the main reason that is true is due to the current standard formula used to set loan repayments. Inflation should not matter! But it does; mainly due to the fact that when inflation gets going, asset valuations significantly depreciate. Pealing another layer off the onion; I’m arguing that the reason inflation matters is due to an asymmetry in the way loan repayments are calculated. The bankers jack up the interest rate to compensate for inflation; but the borrower’s income in nominal terms is assumed to remain constant from the point of loan origination to the final payment. It’s possible to remove most of this wealth destroying effect by assuming the borrower’s payments increase slowly at the same rate of the inflation built into the loan’s interest rate. Doing this significantly reduces the amount of the first payment which would make things like homes much more affordable for individuals and capital more affordable for businesses.

    Let me be clear here, this change does not reduce the inherent contradictions of capitalism; the class war will continue. However, I believe the reform I am advocating for would allow two main things: 1)the economy to operate at a higher level of employment over longer periods; 2) allow a policy mechanism to re-inflate an economy after a financial crisis causes a rapid compression in asset valuations (liquidity trap.)

    There is also a political dimension to the argument I am advancing. The monetarists use inflation fighting as a crutch to justify not pursuing a policy of full employment. While the ink was still wet on the Humphrey-Hawkins bill in 1979, Paul Volker argued the twin goals of full employment and stable prices were impossible to meet at the same time. If inflation does not matter, what is the excuse to not pursue a policy of full employment?

    I actually know what the answer is to the above question. The answer is that wages across the board go up when the economy approaches full employment and start to pinch off profits. The lower profits again reduce the valuations of business assets; leading the right to again demand a “cooling off” of an “over heated” economy. My feeling is to let the right make the case; they won’t have the camouflage of the inflation argument with which to make it.

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