Tuesday, April 10, 2012

Incompleteness (2)

After working out my first impressions for yesterday's post, I went back to Mason's at Rortybomb to finish the read and explore the links.

I tried to read Taylor's article, but if you don't subscribe to the Wall Street Journal you only get a fragment. Nothing relevant.

I read the article on Hoenig and was really surprised.
• Hoenig calls for the breakup of large banks.
• In 1996 he "warned about the dangers of expanding the federal safety net to cover financial institutions trading complex derivatives"
• In 1999 he warned "about big, interconnected financial companies."

Hoenig says several things critical of the bigness of finance. That's significant, because apart from the level of interest rates, what matters is the number of times interest costs occur in the economy -- and that has everything to do with the bigness of finance.

He even says

The central bank has to be, in a way, a neutral player, and yet we find ourselves trying to stimulate, and the effect is further leveraging

"Further leveraging" of course means growth of the accumulation of debt; so we agree on the problem, Hoenig and I. But his very next thought shows that he has not yet put one and one together:

If I thought zero rates would bring jobs, I’d want it forever. But it distorts the economy.

He says it is the low rates that distort the economy. Low rates that lead to further leveraging. I don't think that's particularly true. Graph #1 shows the Effective Federal Funds Rate and the Percent Change from Year Ago of Total (TCMDO) Debt:

Graph #1: The Rate of Interest (blue) and the Growth of Total Debt
The blue line -- the interest rate determined by policy -- rises irregularly to a 1981 peak, then falls irregularly to zero.

The red line shows percent change in debt. Total debt. The three largest increases in debt appear near the middle of the graph: before the 1970 recession, and before and after the 1980-82 recessions. The three largest increases in debt occur while the interest rate was at or near its maximum. So it does not seem to be true that low rates are the rates that lead to increased leveraging.

Graph #2 shows the same:

Graph #2: The Rate of Interest (blue) and the Growth of Private Debt

Both graphs show that leverage increases all the time, except now (since the crisis) and also for a while after the mid-1980s (due perhaps to changes in the tax code). The rate of interest seems to have relatively minor effects on the growth of debt.

So it doesn't look like low rates distort the economy.

One who focuses on interest rates but fails to consider also the accumulation of debt is missing the more significant factor.

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