01 April 2015

Of Some Interest

For a long while now, I've been needling the micro- and quant crowd with respect to understanding and predicting interest rates. The real rate is set by the productivity of physical capital used by business. When business can't figure out what to do with their moolah (demand), as has been the case since at least 2000 (all that moolah went into housing, rather than productive physical capital, for a reason), good old supply and demand drives down price (interest). When business considers yet another web advert platform the wisest placement of capital, well... The reactionaries always claim, now that the rate is low, that the Fed (and ECB and Japan and ...) are killing investment by their actions. Never mind that when rates are high they bitch that Damn Gummint debt (i.e., interest payments) drives out private investment. Cake and eat it too, and all that. In sum, the moolah hoarders want the American taxpayer to ship them 10%/annum no matter what's going on in the real economy. In fact, a sort of bailout: no use for moolah in the real economy, then the Damn Gummint should pay them their God given 10%! Nice work if you can get it.

Well, Gentle Ben has spoken up:
But what matters most for the economy is the real, or inflation-adjusted, interest rate (the market, or nominal, interest rate minus the inflation rate). The real interest rate is most relevant for capital investment decisions, for example. The Fed's ability to affect real rates of return, especially longer-term real rates, is transitory and limited.

The bottom line is that the state of the economy, not the Fed, ultimately determines the real rate of return attainable by savers and investors.

He closes with
The state of the economy, not the Fed, is the ultimate determinant of the sustainable level of real returns. This helps explain why real interest rates are low throughout the industrialized world, not just in the United States. What features of the economic landscape are the ultimate sources of today's low real rates? I'll tackle that in later posts.

It may be time to send him a bill for my consulting services.

No comments: