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TASS — Russia’s Central Bank cuts key rate to 7% for first time since 2014

Summary:
Interest rates represent cost of borrowing and income from saving. Both are reduced by cutting rates. Since is this is a decrease in price, it is disinflationary, which is opposite to what central bankers assume. Savers receive less income, which would likely have been spent on goods purchases. Lower of the cost of firm investment potentially results in lower goods prices. On the other hand, in deciding on a monetary policy using interest rate setting, central banks assume that lower interest rates are inflationary. This is an overly simplistic approach that called into question by the inflationary potential of rising rates and the disinflationary potential of falling rates. Inversely, an increase is price occurs in bond markets, where change in securities price is the inverse of

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Interest rates represent cost of borrowing and income from saving. Both are reduced by cutting rates. Since is this is a decrease in price, it is disinflationary, which is opposite to what central bankers assume. Savers receive less income, which would likely have been spent on goods purchases. Lower of the cost of firm investment potentially results in lower goods prices.

On the other hand, in deciding on a monetary policy using interest rate setting, central banks assume that lower interest rates are inflationary. This is an overly simplistic approach that called into question by the inflationary potential of rising rates and the disinflationary potential of falling rates.

Inversely, an increase is price occurs in bond markets, where change in securities price is the inverse of change in the interest rate. Lower interest rates imply that the market price of previously issued securities rises rise in adjustment to the change in the yield. This is a case of asset appreciation, which is considered irrelevant to goods price level that figures in inflation rate. The increase in asset price offset the decrease in income from lower yields. 

Of course, new issued securities reflect the going interest rate. Lowering interest rates means that the government issuer is injecting less funds into non-government than previously. This lowers the fiscal balance.

Specifically, the Central Bank of Russia is assuming that the lowered cost of borrowing will result in an increase in firm investment and that the lowering of interest income will not significantly affect demand, since income from saving may go disproportionately into more saving, given savers revealed preference for saving. The current central banking assumption is that savers fund borrowers, which presumes a loanable funds theory that has been shown to be incorrect. This disproof was confirmed recently by the Bank of England, but much of finance and economic is still based on the erroneous theory.

This is an MMT-based summary analysis contrasted with current central banking assumptions.

TASS
Mike Norman
Mike Norman is an economist and veteran trader whose career has spanned over 30 years on Wall Street. He is a former member and trader on the CME, NYMEX, COMEX and NYFE and he managed money for one of the largest hedge funds and ran a prop trading desk for Credit Suisse.

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