## Tuesday, February 21, 2012

### Estimating the Factor Cost of Money (2)

Picking up where I left off yesterday...

So I worked out some "average interest rate" numbers, uploaded the file to Google Docs, and cleaned it up a bit.

I'm calling this interest rate the Proxy Average Interest Rate, or PAIR.

 Graph #1: PAIR, the Proxy Average Interest Rate

Now I want to look at total debt and use my average interest rate to figure a total interest cost for each year.

Then I'm gonna want to compare that number, the factor cost of money, compare it to wages and profits, see how things changed over the years, and see how those changes fit in with good times and with hard times.

Got annual TCMDO (debt) numbers from FRED, added them to my Docs file, and figured the interest owed each year at the PAIR rate. I just multiplied TCMDO debt times the PAIR rate. This series I'm calling the Factor Cost of Money, or FCM.

 Graph #2: FCM, the Factor Cost of Money

Next, I got annual GDP numbers from FRED and added them to the file.

And I took a quick look at the Factor Cost of Money as a percent of GDP:

 Graph #3: FCM as a Share of Total Income

Then, because it looked interesting, I compared FCM per GDP to the FedFunds rate.

 Graph #4: FCM as a Share of Income, and the FedFunds Rate

You can see a similarity between the two data series. Sure, because the interest rate is one of the determinants of the Factor Cost of Money. But there is also a difference between the two series, and this is due to the other determinant: the level of total debt, which continued increasing from the early 1980s to the late 2000s while interest rates were falling. So the FCM has been more than the FedFunds rate, ever since interest rates started falling in the early 1980s.

As you can see, recently the FedFunds rate has been down almost to zero, but the Factor Cost of Money has not dropped below 5% because there is so much debt, public and private. And 5% is well above what the Factor Cost of Money was at the start of the graph, when our economy was having its Golden Age.

You might object, saying

Yes, yes it's true: The Factor Cost of money started out well below 5%. But it reached 5% before 1970, and the Golden Age continued on to 1973.

Right! It was the increase in the Factor Cost of Money that killed off the Golden Age.

In the early years, the Factor Cost of Money was less that five percent of GDP and was growing only slowly. In other words, the drain of income from the productive sector to the financial sector was at a minimum. Never again has that cost been so low. And never again have we had a Golden Age.

The Arthurian said...

Point of note: I am trying to establish general behavior here. My FCM is based on a PROXY average interest rate. The 5% number I discuss in the post is representative, not specific.

Hope that makes sense.

Jazzbumpa said...

In other words, the drain of income from the productive sector to the financial sector was at a minimum.

Starting in vary different places, and using very different processes we would up with quite similar conclusions.

http://www.angrybearblog.com/2012/01/where-has-all-money-gone-part-ii.html

Here is one cold solution.

http://www.bloomberg.com/news/2012-02-20/icelandic-anger-brings-record-debt-relief-in-best-crisis-recovery-story.html

Cheers!
JzB