Monday, September 3, 2012

Volcker broke it. Greenspan surfed it. Bernanke ends up holding the bag.

Interest rates have been trending down since the early 1980s:

Graph #1: Collected Interest Rates
Click for FRED source page

We need a concept that accounts for why interest rates trend up for long periods and then down for long periods. But anyway, this is the FedFunds rate since the '50s:

Graph #2: The Policy Rate

The long trend is up, to the Volcker Peak (1981) and down thereafter. The rate went above 19% in January and again in June of '81. Since then it has fallen to nothing. And what has this done for economic performance?

If a fall of interest rates is good for economic growth, then rates falling to zero must be very good for growth, right? You would think.

Graph #3 shows the percent change ("change from year ago") of nominal GDP with the percent change ("change from year ago") of the FedFunds rate subtracted out of it. What it shows is this: For the sake of boosting economic growth, interest rates have been allowed to fall for 30 years. Growth withered all the while.

This does not mean interest rates should be pushed up. What it means is that, whatever we had before that gave us growth, well, Volcker broke it.

Graph #3: The Urge to Grow

Before Volcker, the economy wanted to grow.

After Volcker, not so much.

Next: What's in Bernanke's bag?


Jazzbumpa said...

Think about the relationship between interest rates and inflation. I'll suggest interest is a follower.

I'll also posit that inflation is a resultant of economic expansion. As we slipped into a slow growth mode, inflation fall and interest rates followed.

I'm not suggesting a simple A --> B; things are more complex than that. But there are prime movers, like the moon pulls the tides.

Volker gets credit for slaying the inflation dragon. I've given him that, myself. But now I'm not so sure. Reagan gets credit for the fall of the Soviet Union, too - but I think he just happened to be there when it collapsed under its own dead weight.

Maybe the prime mover comes from policy, but maybe it just IS, like an Elliott wave, and we're just along for the ride.

Fasten your seat belt.


Joshua Wojnilower said...

I'm kind of in the same boat as JzB. Is it possible that everyone gives the Fed credit for having far more sway over the economy than it does in practice?

My position is that the Fed's ability is asymmetric with far more weight on lowering growth and inflation. Congress has a bit more power, but it's similarly unbalanced.

Despite all the "known" policy errors and "successes", growth continues with random fluctuations. Maybe we are just along for the ride.