Loans - Demand Balloons?
If the interest rate on loans that were certain to be repaid was zero, could demand for loans balloon out of control? Not if a few precautions are taken. Borrowers can never really guarantee that they will be able to repay a loan. They will have to compensate lenders for the risk that the loans won’t be repaid. This is a form of insurance that borrowers could be required to pay. The cost of the repayment default insurance would put some downward pressure on demand for loans.
The fact that loans need to be repaid limits what people can spend borrowed money on. If you buy a car, the value of the car drops over time as it slowly falls apart. When you sell the car, you won’t get back what you paid for it. You will need to make up the difference when you repay the loan. Most things lose value over time. Paying for this loss of value limits how much you can borrow and spend even if interest rates are zero.
There are a few things that don’t lose value over time if used properly. Land is a good example. If you buy land and just leave it alone, it will likely be just as good ten years from now as it is today. Things like land that are useful for a very long time create a problem if interest rates are zero. The amount you can afford to pay for land is high because you will get back almost everything you paid when you sell and might get back more if people think up more useful things to do with the land. This means that the price of land tends to be high and fluctuate a lot when interest rates are low. The solution is for government to retain long-term ownership of land and to provide only short-term leases to people who want to use it. I’ll write more about how this could work in my book.
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