Our Misplaced Obsession With Interest Rates

A Bloomberg View piece written by former Fed Governor Narayana Kocherlakota, titled, "The Fed Shouldn't Be Afraid of Growth" caught my interest.

Mr. Kocherlokata is an interest rate "dove," and he has consistently argued against raising rates at this time, as well as against rolling off some of the Fed's $4 trillion stash to suppress longer dated interest rates (which is the rationale for buying Mortgage Backed Securities.)

He writes: "The low inflation has also affected expectations of future inflation. Judging from interest rates on Treasury securities, for example, market participants are expecting the Fed’s preferred inflation measure -- the Commerce Department’s price index for personal consumption expenditures -- to increase at an annualized rate of about 1.5 percent over the next decade.

So for the past four years, the Fed has been tightening too quickly to achieve its inflation goal. Why? The answer, I think, is that it wants to keep the rate of economic activity from getting too high relative to what the central bank sees as the long-run sustainable level."

Far be it from me to argue with a former Fed Governor and a distinguished professor, but it seems to me this statement on inflation and economic growth would apply if rate policy were the ONLY determining factor in the economy. And at this point in economic history, it doesn't seem to matter as much as it once did, or at least at these levels. Once again, let's go to the data. There seems to be no correlation between rates and consumption, even given far more drastic swings in rates over time.

The obverse obsession works with the general public. Millions are convinced of the belief that if they could just get 3% on their One Year Certificates of Deposit, poverty and hunger will be eradicated from the land. Which would be nice if there weren't any other pesky influences on our economy, like wage stagnation, tax policy, the strength or weakness of the dollar, energy prices, de-industrialization, rent seeking, concentration of wealth, health care costs... well, you get the idea.

But interest rates continue to occupy a special place in economic discourse, even as monetary policy has exhausted itself as a stimulus tool. Trillions of dollars in mortgage money have been refinanced at low rates, saving homeowners billions of dollars a month, but as every loan officer knows, the well of people who can or need to refinance eventually runs dry. Auto financing was incredibly cheap, which, along with job growth and steady economic improvement, certainly helped the auto industry reach record unit sales. But as we've seen, demand has plateaued, lenders are running out of customers with decent credit, and with default rates picking up, they've wisely tapped the brakes on funding buyers with a less than stellar risk profile. Corporations have gorged on debt issuance at low rates, regrettably used mostly for stock buybacks and dividend boosts, instead if investing in their own businesses. At one point or another, every policy loses it's sharp edge, and there's little more to be gained by pursuing it, but, to a man with a hammer, everything looks like a nail.

The factors I listed are of far greater importance to the well being of America's citizens than rate policy at this point in time, since things like GDP and productivity mean nothing to the average working person- their lives just aren't moved by these things, no matter how obsessed the econs are about benchmarking them. And that's been the missing element in all of our discourse about economics of late. The numbers are great. What the numbers actually mean to a great many people in the real world is, in many respects, a non-event, because of all of those other factors relentlessly working against them.

So why do we obsess over rate policy? While it's certainly important, I don't think these niggling 25 basis point moves are going to knock the economy off its skis, but it is much easier to point to a group of people who have the power to set rates as one sets a thermostat, while avoiding the hard policy choices those other factors I mentioned force us to deal with. It's more like work. And few have the stomach for structuring the economy so it delivers for more people.

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Donald R. Davret, Investment Advisor Representative

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