Tuesday, September 16, 2014

Interest Rate Hysteria

As I write today, the 30 Year Fixed Rate on Mortgages is about 4.2%. Though MORT30 averaged higher than that in 2010 and 2011, it was below that rate recently and there is much concern that it, like other rates is soon headed upward. When I say there is concern I could also say there is near hysteria.  As I often like to do I checked some historical data and find little reason for undo concern.

Don’t get me wrong. If mortgage rates climb some people will be hurt. Change in any economic indicator has a tendency to penalize some while helping others. Prices of weed in Seattle have gone up since legalization and many puffers would probably prefer to go back to the good old days when the government was not taking its “fair” share of the profits. Inasmuch, prices and interest rates always cut in at least two ways. As you know, however, I am a card-carrying macroeconomist and as such am less worried about distribution and more interested in how indicators impact the whole economy.

Luckily we have macro indicators like real GDP that represent the macro performance of an economy. My data analysis looks at how changes in MORT30 have impacted real GDP.  And while this might sound heretical, I am seeing little concern raised by more than 40 years of annual data (1971 to 2013). That is, while it sounds obvious that increases in MORT30 ought to be terribly bad for the growth of the national economy, there is really very little relevant evidence to back that up.  Today some of us are very worried that the Fed will change policy, jerk interest rates upward, and return us to a terrible recession. The data do not support such a worry.

First I look at recession years. Did rising interest rates cause these recessions?  There have been 6 recessions encompassing parts of nine years since 1970. In three of those recessions -- 1973-74, 1980 and 1982, MORT30 increased and confirmed our worries. But it is important to point out that those years from 1973 to 1981 showed dramatic increases in inflation and MORT30 had reached over 16% by 1981. MORT30 increased from 7.5% in 1971 to 13.7% by 1980 and then 16.54% by 1981 (these rates are annual averages meaning that rates were even higher in some parts of those years). It is questionable how relevant those recessions are to today’s situation of low inflation expectations and interest rates.

In none of the three remaining recessions (1990, 2000, and 2007/2008) was there any interest rate increase during the recession. In most cases MORT30 was falling during or immediately before those recessions. It is seems unclear from this recession analysis that higher interest rates will cause another recession in today’s environment.

Second, I examine the time periods when real GDP growth declined. Did rising interest rates cause slower annual growth? There were 22 years between 1970 and 2013 when the growth rate of the economy declined. That is, the growth of real GDP in those 22 years was less than in the previous year. In nine of those 22 years interest rates rose in that year. Of those nine times when the interest rate rose during a slow growth period, in only five of those cases did MORT30 rise by more than 100 basis points in the year before and the year of the slowdown. In one case MORT30 fell by 222 basis points in those two years before and during the slowdown. There must have been something else contributing to the economic slowdowns in those 22 years. 

In the other 13 slower growth years MORT30 was falling.  If we combine the year of the slowdown with the year before, we find only one year in which there was a substantial rate rise of more than 50 basis points over those two years.

The great majority of recessions and one-year slowdowns are not associated with rising interest rates. Increases in interest rates did have large impacts on real GDP back when rates were historically high and rising but not so much when rates were more normal.

Finally, we turn to the times after 1980 when MORT30 rose more than a few points. What happened to real GDP in those years? 

1993-1994 MORT30 rose from 7.3% to 8.4%. In 1994 the rise of 110 basis points was associated with real GDP growth rising from 2.7% in 1993 to 4% in 1994. Growth did slow in 1995 to 2.7% as interest rates were declining in that year.

1998- 2000 MORT30 rose from 6.9% in 1998 to 8.1% in 2000. That was an increase of 111 basis points in two years. In each of those three years real GDP was increasing at rates above 4% (4.4, 4.7, 4.1). Real GDP grew at only 1% in 2001 but rates were declining in that year.

2005-2006   MORT30 rose from 5.9% to 6.4% for an increase of about 54 basis points that year. In those two years real GDP growth was 3.3% and then 2.7%. By 2007 economic growth fell to 1.8%  and by 2007 we were in a full blown recession.  That recession was attributed to a financial crisis emanating from a bubble in the real estate markets.

Rising mortgage rates do not bode ill for the economy. Often the rising rates are more a symptom of an expanding economy and less a precursor of a coming economic slowdown. Clearly the record is sketchy at best. Most clear is the danger of rising rates in a hyper-inflationary environment.  Lacking such a situation, the Fed can go ahead and let rates start to rise and not worry about economic fragility. The economy is growing and can take the hit. A bigger risk is that by waiting too long to let rates return to normality the Fed threatens a much bigger spike in rates and a return to some of the gloomier days of the 1970s.

I loved my 8-track player, disco music, and my Travolta-like dance moves but I am in no hurry to return to the 1970s.


  1. I'm fairly certain that it takes more than interest rates to drive an economy into recession......like when Jimmah Cahtah was the prez-I-dent. It was his whole domestic policy and lack of a foreign one. Wait a minute! HIs domestic policy was foreign to most of us. Try buying a house in 1981 in Northern Virginia as an Air Force major when the rates are pushing 18%....Couldn't qualify. Life sucked then much as it's sucking now. But the interest rates were just responding to a willy nilly monetary policy associated with a disjointed liberal domestic and foreign policy. The whole conglomeration tanked the economy, and it took a return to a competitive, free market system to boost it. Had the Democrat led Congress enacted all of Reagan's economic policies right away, the small economc sag in his early administration would not have occurred. Just MHO.

    1. Thanks Fuzzy. It is true that it takes more than interest rates to sink the economy. But remember how the Fed drove short term rates above 20% in the early 1980s? That certainly didn't help. Admittedly high and rising rates have contributed to economic slowdowns. But I think we are a long way from such an outcome in the near future. No reason for hysteria...yet.