Weighing the future more than the present: Paying a negative natural rate of interest to the biosphere

The interest rate is a crucial, if not the pivotal parameter in modelling challenges and strategies facing climate change. It reflects our stances towards the future. There are two basic, though conflicting principles how to determine it, as reflected in the seminal debate triggered by the Stern report in 2007, which opposed William Nordhaus’s position. One principle, early championed by Nordhaus, is to use the long-run interest rate established by the markets, as this reflects a sort of natural rate that ultimately mirrors human time preferences. Economists mostly assume that humans discount the future, for many reasons, such that we expect compensation if we give up some present benefit, such as saving for the future. That’s why long-run interest rates, in the average, must be positive. The other principle is deduced from ethics: For example, we might argue that for sheer luck we have been born in the present, and if we consider that we could also have been thrown into the future, and vice versa for future generations, it is only fair to give equal weight to the present and the future. We must weigh the welfare of our future descendants just the same as ours.

Today, we live in a world in which interest rates seem to vacillate around the zero limit in the longer run. Most economists think that this is an abnormal state maintained by central banks to fight the waves of crises flooding our world since the turn of the millennium. However, there are also views that this just masks the fact that zero and even negative interest rates have emerged as the natural rates in the longer run. Imagine the consequences for climate change modelling, especially in the context of Integrated Assessment models which contain a damage function in which the discount rate is pivotal! The future would weigh more than the present, with drastic consequences for policies.

There are many serious arguments in favour of a negative natural rate of interest, and defenders of that view include illustrious economists such as the German Carl-Christian von Weizsäcker. In the established view, a negative rate emerges when the demand for capital is lower than the supply. This is the savings and investment relation, interpreted along the lines of the loanable funds model. That means, if investment opportunities are shrinking and appear to be less profitable, but at the same time the need for accumulating savings increases, the price of capital, the interest rate, will fall. Since the turn of the millennium, several core factors have been pinpointed, such as in Robert Gordon’s theory of the long run decline of productivity, or, as von Weizsäcker emphasizes, demographic change which increases the need for pension savings.

Although I think that all these arguments catch important causes of the macroeconomic trends, there is a deeper reason why the natural rate of interest is negative. This has been expounded by that great maverick in the history of economics, Silvio Gesell, and was in principle recognized by several famous economists, such as Irving Fisher. His point is that we must reverse the roles of supply and demand on the capital market: Savers do not offer capital, but they demand opportunities for savings, which are offered by investors who can make productive use of the savings. As von Weizsäcker suggested, there is a connection to thermodynamics here: If savers build a non-productive capital stock by themselves, this will be subject to degradation in the course of time. Gesell and Fisher imagine a shipwrecked sailor who saves clothing, rusk and other items, which, however, will rot. That is negative interest, or depreciation. If someone can offer to use these resources for productive purposes, and later pays back in kind, she can demand a price for that service, i.e., a discount. Now, just think of humanity in toto: We build capital, both private and public, and even exploit natural capital, and we consume the products. All this goes along with depreciation, erosion, wear and tear, and degradation of natural resources. How can we collectively save for the future? Who is the ‘other’ who can offer a savings service for us? In the past, we could always rely on finding ‘others’ as ‘other economies’, such as recently China saving for the US (the ‘Chimerica’ story). But for humanity, that doesn’t work: We are like the shipwrecked sailor on the island of planet Earth.

Fisher argued that negative interest will not occur in the real world, because competitive markets impose forces that overcome the constraints of the isolated consumer without any other choices. Gesell offers another view: He argues that positive interest is imposed on the economy by profit seeking owners of money holdings, i.e. finance. Since money cannot rot, there is a distinct power differential in favour of finance, who can retain money holdings which cannot depreciate physically. Gesell’s view makes much sense when considering the real world situation where savers decisions are relatively inelastic vis-à-vis the interest rate. Most people save for other reasons than to earn interest, for example, for future emergencies, for buying a car, or for marriage of children. Hence, the reversal of roles applies: Savers are in search for savings services, and they are not ‘suppliers of capital’. Savers pay for these services, which establishes the case for negative interest. In a competitive economy where these services are offered by many businesses (banks, insurance etc.), this creates a force pulling interest rates into the positive domain, but still a very substantial spread remains between interest paid on savings and profit rates by users of funds.

That means, the Gesell theory turns the core relationship in macroeconomics, savings and investment, from head to feet. I think that this is the deeper reason why we have entered a world of interest rates close to zero.

Hence, we can now offer a purely economic, and not ethical reason why interest rates in climate models should be zero, i.e. the future should weigh the same as the present, if not more. In fact, this simply reflects the precautionary motive in ordinary life, as manifest in actual savings behaviour. Human beings are conscious of the uncertainty of the future, and they look for reasonable ways to prepare for and cope with these uncertainties. For achieving this, they are willing to incur costs: They give up present advantages without expecting any compensation beyond the reduction of uncertainty. This constitutes the negative natural rate of interest.

Coming back to the question, who is the ‘other’ who can offer savings services for us? Whom should we pay negative interest and how? Von Weizsäcker argues that this is the government debt, which is exactly what we observe, with bond yields even turning negative. Japan is a glimpse of the future. But I would add another observation: Government is part and parcel of the human economy, and in this sense also part of the technosphere. I suggest that our savings bank, perhaps mediated by government action, is ‘mother nature’, i.e., the biosphere. If we invest into the biosphere, we utilize a savings vehicle that can safeguard the living conditions in our future. The biosphere is the ultimate productive resource and can help us to overcome the forces of degradation that reign in the human economy. If government incurs debt with the primary aim to invest into the biosphere, i.e. building natural capital, this means to pay negative interest to ‘mother nature’.

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