>>Rates are still too high
>>>How could they be any lower?
Short answer is, that is where they have been headed and since BB ran into the lower bound, he has been doing whatever he can to push them down. The EU is about to help too.
Long answer - most may want to quit here.
For "how" see note*, allow me to comment on "why" I assert rates are too high.
Robo** asserted rates should be higher, I suggest they should be lower. How should we think about what rates should be and what determines them? Here I give two approaches that suggest we should have lower rates, that the natural rate should be lower from a supply demand perspective and that Taylor rule calls for lower rates if you want to generate higher rates of inflation.
I suggest that at a macro level interest rates naturally are a derivative of economic activity, particularly growth or decline in GDP. A growing economy creates demand for money. Rising demand, all else being equal (aebe), suggests higher interest rates. The reverse is obvious. Right now the “rising demand” in the US comes largely from deficit spending by the Federal government. Call it 9% of GDP. Will that number go up or down?
Assuming it goes down, demand declines – rates decline aebe.
The supply side of money is saving which we will view very broadly. With slowly growing (at best) sales, businesses are able to internally generate all the funds they need and MORE. In fact, they have become large “savers”, accumulating cash, and/or distributing the finds via dividends and buy backs. Keep in mind that distributions just become someone else’s savings. AND at this point in time the mechanism for transferring savings to spenders/investors, bank intermediation is largely non-functioning. (A related but critical relationship is that federal deficits (fd) are inversely related to corporate profits. Properly understood, that explains a lot. Big fd’s produce big corporate profits. Big federal surpluses produce big private sector borrowing. Think Clinton era.)
IF we are to have higher rates without an economic melt-down (run-away inflation could cause this), then we need to restore healthy economic growth.
As Peter points out, the best way out of the current economic problem is to get the economy growing (example of ng infrastructure for the NE is an excellent example of efficient use of fiscal stimulus) while adjusting fiscal spending and taxation. To promote growth we have two very different vehicles, fiscal and monetary policies. The former is run by warring children*** the latter by an adult BB. The former is incredibly flexible, broad and powerful; the latter while powerful is inherently narrow and limited.
The natural interest rate that I describe is distinct from the interest target rates that the Fed sets. Historically the common understanding was that the Fed only controlled the short end, FFR and short term T’s. We now know better. They can lower LT rates if they wish to. IMO, the Fed needs**** to target higher inflation rates (call it 4% GDP deflator) and that suggests following the Taylor rule that rates are still far too high.
The Fed can’t do it all – but it must play the hand it is dealt by the Congress and the exogenous, as best it can. Congress must help.
ij
* "how" rates go lower will be a function of time, perceptions and world economic activity as they respond to monetary and fiscal decisions.
** In fairness to Robo, his assertion was about what the Fed should do. My point is directed more at the natural equilibrium of interest rates.
*** en.wikipedia.org
**** Inflation would start to change spending/housing/investing behavior for the positive. Once economic activity picked up or Congress did its part, we would see the GDP gap close and lower unemployment. At that point implementation of the Taylor rule with a lower target inflation and interest on reserves tool would offer all the Fed needs to bring inflation under control. |
