Interest Rate Roundup

Monday, April 28, 2008

More Fed policy chatter ...

Great story at Bloomberg about the dilemma the Fed faces as it heads into this week's meeting. It largely mirrors some thoughts I shared late last week. Here's an excerpt:

"Federal Reserve Chairman Ben S. Bernanke may have to start talking and acting more like Paul Volcker if he wants to avoid being remembered as another Arthur Burns.

"With oil and food prices surging, Volcker told the Economic Club of New York on April 9 that 'there are some resemblances between the present situation and the period in the early 1970s,' when then-Fed Chairman Burns let an inflation psychology take hold. 'here was some fear of recession, the oil price went skyrocketing up, the dollar was very weak.'

"It took Volcker's effort as Fed chief to push the overnight lending rate to 20 percent in 1980 and drive the economy into its deepest decline since the Depression to break the inflation he inherited. To avoid squandering the gains Volcker made, Bernanke may need to stop his all-out effort to prop up the weakening economy and start paying more attention to countering price pressures.

"'You have to take the risk of the possibility of a small recession if you want to avoid ending up with a big one,' says Allan Meltzer, a Fed historian and professor at Carnegie Mellon University in Pittsburgh.

"As policy makers meet this week to decide on interest rates, Bernanke has one big thing going for him that Volcker, 80, didn't: Polls show Americans, for the most part, are still convinced the Fed will do what it takes to keep inflation down.

"That may become a self-fulfilling prophecy, as workers refrain from demanding big wage increases they don't think they'll get, and companies limit price increases for fear of losing sales.

"Consumers expect inflation to average 3.2 percent during the next five to 10 years, according to a Reuters/University of Michigan survey this month. That compares with the 9.7 percent long-run inflation rate they expected in February 1980, seven months after Volcker took office."

And here's some more commentary from a Reuters story, largely on the same topic:

"If the U.S. Federal Reserve Board wants to restrain oil and food prices and help downtrodden consumers, the best thing it can do is stop cutting interest rates.

"That is the view emerging on Wall Street, among some economists, and even a handful of Fed officials who worry that the world economy is getting only limited benefit from deep rate cuts, but all of the unwanted side effects.

"Ending the string of rate reductions that began in September would be welcome news for the European Central Bank, which has held borrowing costs steady while its U.S. counterpart cut, driving the euro to a record high.

"Stopping the rate cuts may also be good for developing countries struggling to pay for increasingly expensive food and fuel, and for rich nations worried about inflation eroding economic growth."

A money quote I can't help pulling out?

"'As central banks pump in liquidity to help bail out the financials, the result so far seems to be ever higher commodity prices,'" said Andrew Lapthorne, an analyst with Société Générale in London."

Meanwhile, with regards to the whole "negative real interest rates" discussion, I thought I would share this chart I put together. It computes the real (inflation-adjusted) level of the federal funds rate, using three different measures of inflation (the year-over-year change in import prices, in PPI, and in CPI). You can see that rates are negative no matter which indicator you use. Negative real rates are inflationary/expansionary, and I fully believe they are exacerbating the commodity price rise. In other words, the Fed is accommodating price increases, rather than fighting them.


  • Mike,

    People do seem now to be comparing the current situation to 1980 and the circa 1974 bad periods in the housing industry/economy. Historically, how quickly did those others rebound? From what I remember it seems like the upturn was as fast as the downturn (i.e. no long valleys/plateaus between the peaks)

    By Anonymous Anonymous, at April 28, 2008 at 8:43 AM  

  • Good question. The 1970s were a period of extreme volatility in housing, with (as you say) relatively sharp upturns in the context of a broader sideways trend. I'm using the new home sales figures here as my point of reference since the data I have goes back to 1963.

    However, there was a fairly lengthy "valley" in the 1980-82 timeframe. I would also point out that this boom was of a truly historic magnitude -- both in terms of duration and extent. So I suspect the period of weakness we're facing will be more prolonged, and the recovery more gradual, then in past cycles.

    By Blogger Mike Larson, at April 28, 2008 at 9:48 AM  

  • I don't think previous downturns occurred after such a massive speculative bubble. I think the bust will be proportional to the boom.

    Great blog by the way Mike, regular reader.

    By Anonymous Anonymous, at April 30, 2008 at 6:22 PM  

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