There is an apt analogy to be made with forest fires and recessions.
You can keep forest fires from erupting for decades - and we have done that in much of the American West. But the fuels continue to build up and, eventually, a fire that cannot be managed will explode violently - and cause much more damage than the aggregate of all of the smaller fires along the way.
Business firms fail. Employees of those firms lose their jobs and suppliers are left unpaid. Nobody likes this but it is the circle of life of the economy. Keeping these firms alive with cheap and easy rollover of debt is akin to letting the fuels build up in the forest: when the day finally arrives that these zombie firms cannot finance or rollover debt we will have an explosion of defaults and bankruptcies that consumes far more than the laggards we supported along the way.
We need regular recessions the same way we need regular fires in the forest.
The more the Fed distorts normal market signals, like interest rates, the less efficiently capital is allocated, and so the wealth distribution morphs from one that roughly represents human skill at allocating capital to an extremely top-heavy skewed chart that rewards incumbents.
Why care about wealth inequality as a first-order concern? The periods you identify as decreasing wealth inequality also correspond to periods of decrease in real median income [0]. If my median income is going up, why should I root for periods that decrease it, even if it means that the wealthy are being hurt more than I am? Seems a bit like cutting off the nose to spite the face.
I don't think any action the fed takes can reduce wealth inequality because of the simple reality that there is a capital class, and a class without capital.
Once one has capital, they can take any direction of the market in response to any market condition.
It "reduces" only in the sense that asset values decline for passive holders, but its hardly a different reality for those with negative/zero/five-figure net worth and the whims of those with 7, 8, 9, 10, 11 figure net worth.
I don't see at all how the Fed is manipulating market signals. Public companies are an open book. We know at all times what their financial fundamentals are. Fed does not manipulate this. Aggregate market sentiment develops in a thousand ways, the Fed really isn't puppeteering here.
> market corrections [...] prevent at all cost.
Fed-decision this week cascaded in the wiping out of trillions of equity. Can somebody please explain how they are propping up the capital class, or how they are preventing market corrections?
It seems like a 0% fed rate would corresond to a complete lack of 'distortion'--the effective rate is then 100% a 'market signal', no?
I would think--at least according to this author's thesis--that a moderate level of fed 'distortion', in the form of a moderate-but-certainly-not-zero fed rate, would be desirable.
When has the been the case? I thought the case for index funds went something like "there is no replicatable skill test for assigning capital, so just diversify"
Anyway, the article's main mistake is in thinking that the Fed controls interest rates. It can only control nominal interest rates, not real interest rates (adjusted for inflation).
Like any other competitive market, real interest rates are set by supply and demand. If companies, entrepreneurs, and investors see few ways of investing cash to increase revenue or improve efficiency, then interest rates must be low. Better investment (real) returns can come from new technologies and innovations, or from demographic surges.
Yes, we all want better investment opportunities, in real dollars. But the Fed can't control this.
Better means an optimal risk-reward profile, meaning that you don't lose principal while looking to allocate that capital in search for yield.
The Fed controls the rate of the safest investment there is: money held at the Fed AKA the Fed fund rate. Every interest rate is calculated using that fundamental rate as the point of reference because literally every entity in the world has a higher risk of default rate than the U.S. Federal Government.
So yes they control the most important thing in global markets: the price of safe money backed by 5000+ nukes, largest air force, 2nd largest airforce, 3rd largest airforce, largest navy, largest economy...
The cheap financing allows these firms to disguise the fact that they are underperforming.
So whatever form of "market discipline" might occur, these firms are shielded from it because they can just keep rolling over their debt obligations while continuing to pretend they are competitive in the marketplace.
I think raising interest rates so aggressively now is poorly thought out and is going to bite us in the ass.
In other words, we have an economy running too hot, and raising interest rates will slow that (by how much is another question...)
Accepting sustained inflation is always dangerous; it's exactly what we did in the 1970s. Letting it run up even further now just means a bigger recession later.
Then I heard Kathy Woods say she predicts deflation in about a year.
I my world of the poor, and low middle class we didn't get much out of the low interest party. I guess there's more jobs? We can't afford to speculate on stocks, and those high interest rate cd's were nice 20 years ago.
We can't afford a home, so we didn't get those low interest rate mortgages.
We can't afford new cars, and used car loans always seem high.
Did you guys know the Homeless got 0 government money through the pandemic. (Off topic, but it just bothered me.)
I just heard a big wig business guru say that Jerome Powell should be looking for another job. I think he did an ok job for what he was handed.
What I will never understand about Jerome Powell is why had government buy the mortgage backed securities, and treasury securities for so so so long, especially since realeste and the stock market flourished during the pandemic?
(Yes--I'm no expert obviously.)
Isn’t it odd that during a period of economic turmoil, household wealth increased by the most on record? Indeed this strange dichotomy can be understood in large part by low rates and QE.
What would explain the increase of household wealth pre-2008, before QE was even invented? The economy was in turmoil for a few months but then everything picked up again. GDP, corporate profits surged. Unemployment fell.
Home prices and stocks surged in the 80s and 90s despite high interest rates.
The fed raised rates from 0% in early 2016 to 2.5% by late 2018 and the stock market and economy did fine.
Correlation does not mean causation, as it's said. 0% interest rates forever didn't help japan until possibly only very recently. why is it suddenly different here.
https://fred.stlouisfed.org/series/BOGZ1FL192090005Q
You only get 36% if you measure from the bottom of the sharp V-shaped recession in 2020. If you measure from 2019Q4 to 2021Q4 you get something more like 29%. Still sounds like a lot, but compare 2002Q4 through 2004Q4 - that's also about 26%, it's just not so obvious on the linear scale.
In fact, if you look at the percentage growth over a two-year look-back, household wealth has grown by at least 20% on multiple occasions on that time series.
For comparison, this is what the same timeseries looks like if you plot it ending at the end of 2004:
I was hoping for an answer but alas there was none. Anyone have plausible theories? Is this an unexplained mystery or just an artifact of S curve growth?
The economy was in turmoil in 2007? There were problems at a few banks, but other than that, spending and investment was extremely optimistic.
House prices hadn't started to decline, and they were coming off their biggest 6-year increase in a long time. HH wealth was at an all-time high for most of the year.
We've already realized a ~10% increase in the CPI.
Presuming that houses are included in this metric, those are currently pretty inflated in value.
As of December 31st 2021, the market hadn't even really started to pull back yet.
If you say that household wealth has increased nominally, in terms of there being a bigger number of dollars, sure. But I think you have a pretty hard case if you want to argue that _Real_ household wealth has increased very much.
If you're spending $2k/month on rent vs interest, taxes, and equity, with the idea that you'll get at least the value of the equity back when you sell (and probably more, when inflation is higher than a fixed rate mortgage) you'll come out ahead no matter how long you hold the debt.
And frankly 40 year mortgages are probably better than 30 years with debtors that can't afford the monthly rate. It's like 72 month car loans, it's a better deal for everyone.
I am by no means an expert, but this doesn't make sense to me. If the choices are runaway inflation and making higher interest payments and making the debt to GDP ratio worse, the choice seems obvious.
No.
The Fed is raising rates. They raised rates yesterday. They say they intend to keep doing so through the end of the year. Net interest is a low single digit percent of the federal budget; it's lower as a fraction of GDP than it was in the 90s [1]. Most of the federal debt is fixed rate--raising rates now only affects future borrowing.
The real limit on rates is growth and employment. If the economy falters because people are spending all their money on servicing debts over goods and services, we'll see a crunch. That's not happening. The opposite is happening: inflation is surging.
I think the question is: can we sustain 5%+ interest rates? The answer is no - unless GDP increases precipitously or government spending declines A LOT.
Imagine 5% is the new norm. In 30 years, the government will have 100% of public debt at 5% interest. At 139% debt to GDP - that's 7% of GDP going to debt financing. Federal revenue is only ~18% of GDP.
That means 38% of taxes would go to debt financing. And if trends continue - within 30 years, public debt to GDP would likely be closer to 180%. So 50% of taxes would go to debt financing. It's simply not possible long term (unless there is some MASSIVE unknown boost to productivity to save us).
Interest rates might go up to 20% for a year here and there. Who knows. They'll be hovering around 0 or negative and steadily going lower for most of our lives - unless we reach the singularity.
[1] https://www.treasurydirect.gov/govt/reports/pd/feddebt/fedde...
i think it's more political. A while back I was driving to pick up my son from a school thing and there was an interview on NPR with the fed. I can't remember the exact date but a number of months ago. The fed was going on and on about how great the Build Back Better plan is and was going to be and now the inflation that was beginning to show was all due to supply chain issues and will be sorted out in a few months.
I think the fed didn't want to raise rates and held out this long for political reasons only. Now, not raising rates presents more risk to the administration in power than raising rates and so here we are.
Who exactly at the Federal Reserve was praising an Executive branch policy "on and on"?
To do so would be an extraordinary lapse from the principle of central bank independence. Evidence is required.
Tech has been Americas golden goose for the last decade and high interest rates are like kryptonite for tech. All those flashy startups burning hundreds of millions with only negative profits to show for it are a direct product of a low interest rate environment.
The fed knows that raising rates will likely result in the goose losing most of its feathers, and the carry on effects from that.
USA can you use Federal Reserve to monetize debt at low rates. Europe and others can't.
Pensions have been hit hard since 2008 because laddered bonds no longer yield sufficiently.
The solution is a worldwide government debt default, with UBI after pensions default. While I don't want this socialism, world politicians seem to follow Klaus Schwab's idea on this.
It isn't important. It's been made important by financiers.
What the last 50 years have shown is that trying to manage an economy by trying to influence the amount of credit is a fool's errand.
Instead we should set that ship free - and leave it up to the private sector to determine interest rates amongst themselves. That means anchoring monetary policy at zero base rates.
Instead we should be rationing firms access to labour by pushing for higher wages with a much higher minimum wage and preferably a guaranteed job for all at the higher minimum wage.
What we need to make firms efficient is reassuringly expensive labour. That way they will use the cheap access to capital to borrow, invest in technology and drive forward productivity - solely so they can use less of the expensive labour.
It's time to get banks, lending, and finance out of the prime path. As the Chinese have.
When I take the risk to loan out money, I want more return than zero. Why would anyone bother at zero?
Maybe reading the enabling legislation would be useful. https://www.law.cornell.edu/uscode/text/12/225a
' maximum employment, stable prices, and moderate long-term interest rates. '
I'm interested in the forgotten 'stable prices' part.
Why do banks have to follow the federal rate for certain types of loans? IIRC the rate is used for interbank loans against federal reserve deposit requirements, but why would they follow the Fed rate for this rather than some other market force? I don't think it's required by statute (is it?).
What, if anything, prevents banks from ignoring federal benchmark rates all together?
If they go too far one way, people will use other banks. If they go too far the other, they waste money.
Also, there comes a point where they could just invest that money in someone else rather than offer the service themselves, and make more money. That keeps things from going too far that direction.
And finally... Deciding things is hard. When someone else decides things for everyone, legally, it's an easy choice to follow it. Most of the time that's price fixing and is illegal.
Bingo!
That's the answer, the fed funds rate is a price fixing tool. Banks via the federal reserve governors meet to decide the base interest rate from which most other interest rates are derived. Aka the "price" of money. This is done to optimize the rent seeking activity of loans. The banks want to optimize how much interest they extract from the productive economy without harming it to the degree it stops growing or shrinks.
Related, most people think the Fed IS the government but it is not... it's banks... https://www.stlouisfed.org/in-plain-english/who-owns-the-fed...
Banks don't have to follow the federal rate. It's the "zero risk" rate that anyone can get. Beyond that, higher return generally means higher risk, with the risk premium set by the market. If you originate a loan with a wildly low APR, then you'll certainly get borrowers, but nobody will buy the debt from you, and you'll lose money. If you try to originate mortgages with higher than market APR, you won't have any takers.
If supply decreases but there's also a ton of cash splashing around, then people try to use it to get things... But there's not enough things, so the price of everything gets bid up.
More than 20% of all dollars in existence were "printed" in the last 2 years. This, on it's own, would tend to increase inflation. Combined with supply side issues, we can see how it has definitely increased inflation.
Inflation itself is also an issue in terms of making sure the supply side works well. Prices don't go up smoothly and uniformly for everything at once, rather there's chaos and delays as every step of everything gets renegotiated, and a cascade effect from that that causes more disruption.
So, you want to deal with inflation, probably. Increased rates mean less money being "created" in the form of credit, which means fewer dollars splashing around, which means fewer dollars to bid up the prices of short supplies, which means lower inflation, theoretically.
Most of inflation right now is being driven by shortages, firm profit taking, and wage increases.
The first two can be solved and should be solved by increasing supply and competition.
The third is not a problem at all. The capital side has taken the lion's share of productivity increases over the past 30 years and that has certainly impacted consumer's ability to spend. Wage increases are a good thing in this case and will drive further improvements in productivity and automation.
When supply is too low, inventories are restored by producing more goods than we consume. That also happens to be the definition of saving. Higher interest rates incentivize saving. Therefore, higher rates create the correct incentives to resolve a supply-side problem.
"According to Taylor's original version of the rule, the nominal interest rate should respond to divergences of actual inflation rates from target inflation rates and of actual Gross Domestic Product (GDP) from potential GDP"
https://en.wikipedia.org/wiki/Taylor_rule
Some argue that the reason we have seen such extreme speculative bubbles in recent history is because the Fed has no Taylor Rule-like systemic policy related to market factors. They are free to make policy completely divorced from the market.
https://www.ft.com/content/ece92145-443d-4e94-bfa9-7fe06cb9c...
The Fed's mandate does not do this, and we very often have way to much debt followed by short spikes of not enough debt, so we are destined to continue the boom and bust cycle.
The way I see it the major problem happens to be with when we take out debt on zero-sum goods. When you take out debt and create something new with it, and that debt pays off, everything is fine. When you take out debt to buy something like land, it messes up a fundamental balancing force and speculation runs amok.
Raising rates will likely massacre debt dependent companies.
What you really want to be concerned about are enterprises, large or small, established or starting out, that are impacted by first order effects of interest rates. The obvious examples are the mortgage and real estate industries.
Second order effects are going to be harder to suss out but companies that have large lag times between production of a product and receipt of cash for that product will be adversely impacted. Companies with costs that are hard to restructure are also problematic because (in the US) getting rid of people can be much easier than getting rid of long term leases or debt in raising rate environments.
That is to say, in a raising interest rate environment lots of other items top the list of problematic before VC funding. In fact, it _may_ lead to companies getting more freedom as the VC funds needn't return as much as they do in the current rate environment.
As always, keep enough money on hand to ride out a job search, keep your skills sharp and your professional network built is about all that you can say you should do to prepare for changing macroeconomic regimes.
Secondly, we can immediately ban the purchase of Crytpocurrencies, to drive down the price and hence attractiveness of mining and electricity rates.
Government action needs to be at the supply side.
What's the mechanism here?
However, it is supposed to be independent from the politicians on a day-to-day basis, and people seem to like it that way.
I believe you are somewhat wrong in stating the Fed is not government.
Admittedly the title alone kind of tells you they have a bias.
Edit: Why are you apologizing for people that do not care about you and also rule over your life?
With interest rates so low, money is poring into the stock market driving it up. This is helping the wealthy. But I also think the interest rate problem is caused by wealth inequality, with more invested money chasing fewer productive lending opportunities, and this is because more money is in the hands of savers and less in the hands of spenders.
I personally am hoping after the inflation rate comes back down we see larger net wage inflation than price inflation, returning money to the hands of the working class. (Of course, it would be tricky to push for this too much as a policy because we certainly do not want to cause a wage-inflation spiral. I don't think that is a given though. As they say, the best cure for high prices is high prices.)
And the Fed is not quantifying stealth consumer inflation, which people do notice in spend, namely "shrinkflation" where consumer goods manufacturers reduce the amount of corn flakes in the box and hold the price the same. This was a trend happening before the headline inflation number started to move.
The Fed doesn't calculate CPI; BLS does. And they do consider quantity [1]. Mainly to account for quantity discounts. But it takes care of shrinkflation, too.
Another reason for higher market interest rates is it's a forcing function on entrepreneurs to make them think harder about what they spend social resources on.
Think of it this way with an interest rate of 0* , you merely need to trade a dollar for a dollar in order to service the debt. Many would be entrepreneurs will pursue ideas which have an EROI in the [0-1]% range just because they're expected to return _something_ . However this deploys many societal resources that marginally keeps them from better ideas, should they simply wait or innovate longer. If interest rates were, say, 5% then entrepreneurs must find ways to increase resources by 5% at a minimum just to service the capital. I think this is part of why we've seen so many shitty ideas come from startup over the years. Because a net 0 outcome has minimal repercussions . Yes obviously everyone wants to be a billionaire, but thinking of every gamble having a spectrum of outcomes, it means a gambler can continue to gamble on lower payouts if the "rake" is much lower.
* Consider all of this net of inflation and mandatory minimum returns etc. so that we can speak simply about interest rates.
And that's the point where inflation will be stopped by policymakers.
The asset bubbles that have been blown up were of no real concern because that makes the rich get richer, and is indeed regressive.
Now that it looks like wage inflation for the average joe might happen (which is not regressive at all), it suddenly has to be stopped at all cost.
But ultimately this will trigger an extraordinarily painful recession/depression in order to accomplish it.
There's two ways out of this. One would be to tolerate wage inflation until it caught up with asset price inflation, with rates rising naturally as investor expectations for inflation increased, this would actually produce more stable long term higher interest rates. The other way is for the fed to jack up rates until the economy goes into a recession, throwing a massive number of people out of work and destroying retirement savings for the rest of the bulk of the population and then having asset prices readjust downwards (which must eventually happen). But that latter path won't result in high long term rates since the bond markets will price in the coming recession and that the fed will once again drop rates to zero in the depression (and ultimately we have to eventually hit the "pushing on a string" condition where fed can't even reflate asset bubbles by ZIRP).
The very fact that everyone in the managerial class is so terrified of the current inflationary environment is why everyone should be more concerned with the fed slamming on the brakes and the coming disinflationary depression.
There are other arguments for higher interest rates, but the analysis in the article strikes me as too simplistic.
It's sad the author feels they even need this disclaimer. Its interesting how much gets lumped into a political cause (that requires inheriting all associated political causes of that party).
