I have been posting about the natural rate of interest. The idea is that labor share is falling below an optimal level. We see food stamps rising. The other side of this coin it that capital share is rising above an optimal level. The result is that labor is losing liquidity, while capital is gaining liquidity. We see the effects in stock prices, bubble asset values and record-high corporate profits.
So if capital income has so much liquidity, and labor income has so much less, then in theory there should be a different natural rate of interest for each one in order to achieve balance. The following graph shows the natural rate of interest based on labor share falling below its optimal level.
The plot of the natural rate of interest declines over time reflecting labor's loss of liquidity power. Labor liquidity is important in the goods market. Labor purchases the finished goods that the means of production produce. Capital income maintains the means of production. So labor's liquidity is important to keep those means of production working.
Interests rates are low to encourage labor to hold cash and spend it in order to keep the capital equipment working. At the same time, capital income is enjoying the low interests that are designed for labor.
Well, the line of the natural rate of interest in graph #1 is designed so that labor can have more liquidity to spend. But the line has a flip side. If we adjust the natural rate down for low labor share, then we also need to adjust the line upwards for high capital share. This is what we would see...
The blue line is the adjusted natural rate of interest for labor to purchase goods and hopefully produce inflation. The blue line refers to the consumption market. The yellow line is the adjusted natural rate of interest for capital to develop the means of production. The yellow line is the means of production market.
In the 60's and 70's, capital was at a disadvantage by having to use the higher natural interest rate for the consumption market. However, there was labor demand for more production, so capital was able to profit with growth, but at a cost.
Now, capital has a huge advantage in having access to money at the lower natural rate of interest designed for consumption. Capital can have liquidity at low cost, but there is low labor income demand in the consumption market to attract capital's excess liquidity. No wonder that corporations have large cash reserves and look to invest overseas.
Inflation follows the Labor Natural Rate of Interest (consumption market)
Inflation is how the price of goods & services are influenced by consumption demand. When labor's income is weak, it is harder to increase prices. So we would expect that inflation follows the decline of labor's liquidity. In fact, this is what we see...
This graph shows that inflation (purple line) has been declining with labor's natural rate of interest since the 1980's. If we look back to the 70's, we see volatility in inflation, which is partly due to labor's excess liquidity in comparison to capital's costs to produce goods & services.
For some years after the Volcker recession of the early 80's we had balance between the natural cost of money for capital and labor. Yes, there were problems still, but inflation came under control as labor's excess share liquidity began to decrease. Capital found it less expensive to invest because capital used the lower natural interest rate of consumption, which was then lower than capital's natural rate of interest. Capital began its boom & bubble period, which lingers even stronger to this day.
Exchange rate between labor & capital - A wild idea
So how can this imbalance between liquidity of labor and capital be rectified? We could charge capital income the higher rate. I am trying not to laugh. That idea is far from reality.
We could institute an exchange rate between capital owners and labor. There would be one currency for capital owners and another for labor. A labor dollar would adjust to equal a capital dollar. Such that when labor is paid, there is a currency exchange. And when labor purchases goods & services from a business, there is a currency exchange. The exchange rate will maintain liquidity balance and purchasing power parity throughout the economy.
The extra transaction cost would be offset by economic efficiency.
If an exchange rate was instituted now, labor currency would increase in value at the expense of excess liquidity in capital currency. The result would be more demand for goods & services, more output and more inflation through the exchange rate mechanism.
But as it is now, a dollar in the hands of labor has less value than a dollar in the hands of a capital owner. I propose that this difference in value is due to their natural rates of interest.