Saturday, March 25, 2017

"there seems evidence that interest rates follow nominal GDP"

The title is a quote from Richard Werner.

If I have it right, he means that interest rates follow the growth rate of nominal GDP. Now I have a problem, because the growth rate of nominal GDP is a bullshit measure. When you are looking at economic growth you look at inflation-adjusted values, not nominal values. Always.

So maybe Werner is not looking at economic growth?

Clearly. But say he has a reason for using nominal values. What then? Then of course interest rates follow GDP, because when inflation makes nominal GDP go up, the Fed responds by making interest rates go up. And then, when high interest rates bring inflation and nominal GDP growth down, the Fed responds by bringing interest rates down. So interest rates follow nominal GDP growth on the way up, and interest rates follow nominal GDP growth on the way down, because that is the way monetary policy works.

Richard Werner seems not to know this. He sees the way monetary policy works, and he says interest rates follow GDP, and therefore (he says) interest rates cannot be the main tool of monetary policy:

Thus instead of the central banking narrative that lower rates lead to higher growth, the empirical and verifiable reality is that higher growth leads to higher rates and lower growth leads to lower rates. If rates are the result of growth, they cannot be the cause.

Monetary policy works by raising rates when inflation raises (or threatens to raise) nominal GDP growth. That's how it works. Werner sees interest rates following nominal GDP and says because they follow, rates have no influence on growth. I have to say it again: bullshit.

So much for nominal. Here's what happens with interest rates and real GDP growth:

Graph #1: RGDP Growth (blue), the Interest Rate (red), and High-Side Trends
Not much "following" going on there, is there.

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