## Thursday, October 1, 2015

### How much of that was interest?

If we take "Household Debt Service Payments as a Percent of Disposable Personal Income" (TDSP) and multiply it by "Disposable Personal Income" (DPI) ((and divide it by 100)) we get Household Debt Service Payments in billions of dollars. Those debt service payments include both interest and principal.

What portion of those debt service payments is attributable to interest costs? And what portion to principal?

Take "Monetary interest paid: Households" (W292RC1A027NBEA) and divide it by Household Debt Service Payments in billions ((and multiply it by 100)) to get interest costs as a percent of debt service payments:

 Graph #1: Interest as a Percent of Household Debt Service Payments
Eh, kinda boring.

Okay, let me add a line showing the other part, principal as a percent of household debt service payments:

 Graph #2: Interest (blue) and Principal (red) as Shares of Household Debt Service
Now it is pretty easy to see a decline in interest and an increase in principal since the early 1980s. Many factors must have contributed to these trends.

jim said...

I think saving has been what has driven interest rates down.
Saving usually involves loaning the money to someone who pays interest.
When there is more dollars that people want to save than there are dollars people want to borrow than interest rates fall. Lower rates reduce the dollars people want to save an increase the dollars that people want to borrow. The long downward trend in interest rates tells me the desire to save has been continually growing more than the desire to borrow.

Greg said...

When I first read your comment Jim I thought you were making an argument like the "loanable funds" crowd. On a second reading I saw that it wasn't so clearly a loanable funds argument, but this part;

"Saving usually involves loaning the money to someone who pays interest"

sounds wrong. You seem to be saying that the money people borrow comes from people who have money to save. Which I think is demonstrably false.

jim said...

I'm saying the for every dollar people attempt to save needs someone to borrow a dollar. The borrower could be a bank, or a mutual fund, or a ETF, or corporate bond, or a govt security, or whatever. Every dollar saved is either lent out or stuffed under a mattress, but mostly it is lent. People either spend or lend their income.

Interest rates reflect the balance between saving and borrowing. If people became less inclined to save and more inclined to borrow then interest rates would tend to move up. And if people were less inclined to borrow and more inclined to save interest rates would tend to go even lower than they are now.

The Arthurian said...

Jim: "If people became less inclined to save and more inclined to borrow then interest rates would tend to move up. And if people were less inclined to borrow and more inclined to save interest rates would tend to go even lower than they are now."

I like this explanation because it is basic "supply and demand" stuff. It explains not only why monetary policy (raising and lowering interest rates) works, but also the long-term decline of rates since 1981 and the long term increase before 1981.

Greg, that sentence you quoted from Jim also made me stop and question it. If I put money into a savings account at a bank, Jim says I am lending to the bank and the bank is borrowing from me. That's not usually how I think about saving, but it seems to be correct.

jim said...

"I like this explanation because it is basic "supply and demand" stuff. It explains not only why monetary policy (raising and lowering interest rates) works"

No actually it explains why monetary policy doesn't work the way you think it does.

When has price control ever worked to regulate supply and demand?

Putting the income you don't spend in a bank saving account is not much different than putting it under your mattress in terms of interest paid. 7/8 of money saved/lent is outside deposit banking. The Fed could increase bank deposit and loan interest rates and that would only marginalize bank involvement in saving/lending even more.

geerussell said...

Now it is pretty easy to see a decline in interest and an increase in principal since the early 1980s. Many factors must have contributed to these trends.

I'd suggest that the trend on interest payments is a simple policy story with the Fed ratcheting down rates over time in an attempt to use interest rates as a macro stabilization tool. Interest payments are lower because rates are lower and rates are lower because the Fed lowered rates.

Greg said...

"I'm saying the for every dollar people attempt to save needs someone to borrow a dollar. The borrower could be a bank, or a mutual fund, or a ETF, or corporate bond, or a govt security, or whatever. Every dollar saved is either lent out or stuffed under a mattress, but mostly it is lent. People either spend or lend their income."

I'd reword that this way;

For every dollar people save someone spent that dollar and that dollar was most likely credit from a number of institutions who have been granted the authority to issue credit denominated in dollars. Every dollar saved is either in the form of cash or shows up as deposits in banks or other lending institutions. Most dollars are deposited into lending institutions. People either spend or save their income.

Greg said...

"When has price control ever worked to regulate supply and demand?"

When you are a true complete monopolist and are the ONLY supplier of something. However most smart monopolists pick either price or quantity to control.

The Arthurian said...

I'll quote the same line from Jim: "When has price control ever worked to regulate supply and demand?"

I think Jim's remark was meant as an explanation of his statement that "monetary policy doesn't work the way you think it does." And I think his explanation (in fewer words) is that price control doesn't work.

But deciding where you want the price of credit to be, where you want the FedFunds rate to be, that is not the same as price control. It would be price control if the Fed said "Okay, from now on you can only borrow at two percent [or 0.25% or some other number] until further notice, no matter what." But the Fed doesn't do anything like that.

Rather, the Fed says: "Okay, we think the rate that is best for the economy is 2% [or 0.25% or whatever] and using this internal guidance, we will vary the supply of FedFunds in order to bring the rate to the target."

The Fed dances with wolves, one of many participants in the FedFunds market. The Fed's goal is not to have more FedFunds for themselves, nor to have less. The Fed's goal is to do what is necessary in order to get the rate where they want the rate. Given the target they have chosen, "what is necessary" depends on the state of the economic environment and the spirits of the other market participants.

This has nothing, nothing at all to do with "price control".

Greg said...

"The Fed's goal is not to have more FedFunds for themselves, nor to have less"

Right, the Fed doesn't need FedFunds they create them exnihilo. They are of no use TO the Fed but they are of use TO the banking system.

jim said...

The Fed doesn't have monopolistic control of interest rates.
It has a control over a interest in very tiny portion of the
total credit market.

If the people who have savings woke up tomorrow and decided they had saved enough and it was time to stop saving and start spending from their savings, interest rates would shoot up in response. Not only would their be less demand for the debt instruments where savers put their savings there would be more demand for borrowing to meet the demand for more output from increased spending (more investment opportunity). Both sides of the credit market would be pushing rates up.

Conversely, if people woke up tomorrow and decided they need to save more and spend less of their income, the opposite would happen. Interest rates would go lower because there would be increased demand for the interest bearing credit instruments and lower spending and output would decrease the inclination to borrow.

It is true that the govt is the largest borrower of savings in the economy so more govt borrowing would tend to push interest rates up if you assume that the inclination to save remains the same.

Greg said...

Lets be clear about this Jim. I think often times when we say the Fed controls rates many people take that to mean that they mean private bank/ credit card/ mortgage rates etc. That is clearly not the case. Banks can charge whatever they feel they need to make a profit. The Fed has a great deal of control over the rates of govt debt, and the amount of control has been limited to the short end of the yield curve ,mostly but they can buy all along the curve if they feel they need to. See "Operation Twist"