I have been pretty consistent in this blog that interest rates ought to be raised. Today's post looks at some data to explain why it makes no sense to keep interest rates low forever. And really, do we think interest rates are the best tool to overcome the negatives of a trade war?
The mantra for low rates comes from those who simultaneously love low rates and hate high rates. They love the low rates so they can borrow gobs of money and add to their ever-growing collection of cool cars and stunning shoes. Clearly these people do not like to save money. They hate higher rates for I guess the same reason.
Sophisticates like to point out that interest rates ought to have something to do with expected inflation. If inflation is expected to be low then interest rates ought to be low too. These highly sophisticated individuals seem to discount everything else that is going on in the world. All that matters is expected inflation and interest rates. How nice it would be if the world was always so simple and easy! One could always boil everything down to two things!
To elaborate this world of only two things I asked Fred to draw a graph with two indicators -- the interest rate on 10 year US government bonds and the inflation rate (one-year percentage change each month of the consumer price index) from the early 1960s until now. The percentage change in the CPI is an indicator of past inflation but it's impossible to look inside people's heads for their future expectations and I am content to measure expectations with past performance.
What does the below chart say? Notice that the blue line (interest rate) is often well above the red one (Inflationary expectations).There were many months when interest rates were much higher than inflation. This was especially true during the 1960s and then again in the 1980s and 1990s. Somehow we lived through all those years without crisis. It is true that there were recessions scattered during those years.
You might point out that there were recessions in those years but if high interest rates above inflation are so disastrous, why weren't there more recessions! And if you look at the chart closely you will notice that those recessions came after very large increases in inflation. Notice at the end of the chart how low the inflation rates are. Inflation is barely noticeable recently. Should the Fed really be so worried that a gradual increase in interest rates is going to cause a recession when inflation is so low?
It is true that interest rats have risen since 2015 but notice that the rise came from basically zero interest rates. Compare today's rates to any point you choose before 2015 and you have to conclude they are very low. How can one say they are too high? Do they look especially high relative to inflation? I don't think so.
The upshot is that the Fed has plenty of room to gradually raise interest rates without any real calamity. Of course if a trade war or Brexit or any one of a number of risk factors surface, we might be headed for a recession. But the Fed keeping rates so low today will do virtually nothing to save our economy from those shocks.
The Fed could be a real leader here. Educate people that normal interest rates are important for our country. Explain why keeping rates too low for too long is damaging. It ain't so hard. But I guess when central bankers turn into politicians, simple things sometimes can get hard.
Dear LSD. I’m not convinced low interest rates are worrisome and that even a slight increase to “normal” (whatever or whoever defines that . . . ) is desirable or would be effective or at least inconsequential. The following situations dissuade me from jump’n on your ‘raise rates’ wagon. Recent stock markets’ action have been inverse to rate increases or mention thereof—as I write the Dow is at session high +432 following Powell’s comment earlier. Heck, if that inverse relationship holds (irrespective of the ‘r’ factor) I vote for negative rates to buttress my piggy bank. Secondly, higher rates will increase the national debt service, the debit is already out of control, and no efforts to lower it are on the horizon. Home ownership, auto sales, global economies—recently reported as slow or slow’n—would further soften with higher rates. Consumer debt will take longer to pay off. Seems like a lot-0-heavy lift’n for no reason other than to jez ‘normalize.’
ReplyDeleteWith ample room for the Fed to raise rates I say wait for a compell’n reason to do so and in the meantime grab that three gallon boddle of JD you keep next to your bed. Cheers!
I didn't know that Tunas could become strong liberal Keynesians. You seem to have graduated from the Paul Krugman school of dreams and wishes.
DeleteThe best thing for your wealth accumulation is good government and that means not pissing about higher rates -- but rather demanding those idiots in DC not have such a large debt. As for the Fed coming to save your day with lower rates please tell me how lower rates will offset all the negative impacts of a trade war...or AI or whatever. What matters for your wealth is not hocus pocus from DC -- but good policies that directly address our fundamental challenges.
Dear LSD. I see in the blog only two variables mentioned: interest rates and inflation—not other variables such as trade wars, AI, or whatever. So, since you erected them it seems that should trade wars, AI, or whatever wind up being economically beneficial rates could rise or fall. Heated economic activity (e.g. really good trade, AI, or whatever) could be inflationary thus higher rates. On the other the other hand (hey, hey) should trade wars, AI, or whatever result in beneficial moderate econ activity rates could rise moderately or not increase. On the other the other hand (hey, hey)2 should trade wars, AI, or whatever result in calamity then rates could skyrocket. Anywho, your erection of trade wars, AI, or whatever seems unrelated to aforementioned interest rates and inflation. Too many variables to spekelate ‘bout effects of lower rates thereon. My buddy Krugman may know; I’ll ax him.
DeleteSimple points.First, the graph shows that interest rates are very low. Second, the graph suggests that gently rising rates would not cause a calamity. Third, interest rates have nothing to do with problems caused by trade wars, AI, etc. Interest rate policy is just hocus pocus and distracts us from attending to what's wrong with this country. I rest my case.
DeleteI like simple. But why raise rates just to ‘normalize’—whatever a ‘normalized’ level is? ‘twas not I who erected the topic of trade wars, AI, or whatever in the context of interest rates. If interest rate policy = hocus pocus why have a policy at all . . . . just let market forces determine interest rate level?
DeleteYour case is rested and I think you need a nappy nap . . . and a swig of that three gallon JD @ yer bedside. You’ll be mighty rested afterward.
Milton Friedman believed that the Fed should be replaced by a computer that increased the money supply by a known and constant rate each year. He might choose 5 or 6% per year -- enough for 3% real growth and 2-3% inflation. In that case interest rates become endogenous and market driven. I like that. Problem today is that rates are not market driven -- because the Fed sets targets and moves the rate where they want them to go. Perhaps market rates are much higher right now but the Fed simply won't let them adjust? Free them baby. Let the rates rise!
DeleteT-rates, determined by supply and demand, are low—market driven. Looks like we agwee that rates should be driven by the market and not by the Fed, as me thinks you suggested in yer blog. My most sincerest apologies should I be inkerect. If the market sez, “Let the rates rise,” then so be it 'n stocks fall where they may.
DeleteI don’t think Friedman’s computer could have foreseen the vagaries precipitated by human folly sufficient to effectively control the money supply and achieve a precisely desired inflation rate. It’s counter-intuitive—and at least incredulous—to believe a computer-controlled monetary policy could ever be endogenous and market driven. AI was only a flicker in the mind then, unproven and not developed, and even now the best minds can’t predict AI will ever be better than humanoids’ inherent folly. Garbage in—garbage out.
Yes, we agree that the rates should be market driven. Friedman was making a little joke about the computer. What he was trying to say is that monetary policy should be exogenous. It should not be swayed by cyclical factors. People should expect that the Fed would supply money at a rate that is proportionate with the needs of commerce in the long-run. If AI or anything else disturbs the long run needs for money then Friedman would have factored that in.But he would have been very much against changing monetary policy to meet short run counter-cyclical objectives. He would have hated the current Fed. The current Fed seems to think they can fine tune the economy. Raise rates when inflation seems a short run problem. Lower rates when it isn't. Friedman would say this just makes things more unpredictable and more volatile.
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