One of the persistent themes of this commentary has been the near-impossibility of returning to a “normal” interest rate regime—i.e., the conditions that persisted in the 1990’s and early 2000’s (with the exception of Alan Greenspan’s unprecedented reduction in short-term rates from 2002-05). In those years, the Fed set overnight rates at 3-5% and long rates correspondingly fluctuated between 4-7%. When Ben Bernanke lowered rates to near zero in 2007-08, the implicit assumption was that these rates (along with large-scale Fed purchases of Treasury debt in its Quantitative Easing (QE) programs) were emergency measures imposed in response to a crisis and that in due course the old structure would return as the economy recovered. However, as with many crises, the return to the status quo ante bellum has proven to be elusive even after the storm has passed. It took Bernanke five years to even begin to suggest that the Fed Funds rate would be raised, and his successor Janet Yellen was willing only to implement a few paltry quarter-percent hikes during her four-year tenure.
The current Fed chairman, Jerome Powell, has thankfully raised rates at a much faster pace during his first two years in office —and as a consequence has become a scapegoat for the fourth quarter equity market plunge in some circles. The business of blaming others is an old game in Washington and usually involves the disingenuous confusion of correlation and causation. But Logic at the best of times holds little sway on the Potomac—and we are sure there would be small argument with the observation that the last two years have not been the best of times. If Reason has a Twitter account, it can boast of few followers.
It is far from clear to this commentator that incremental and limited interest rate increases do much to either slow the economy or reduce inflation. This apostasy, however, has little effect on the actions of the Fed policymakers, and they will likely cease hiking rates in the near future, leaving us far short of the “normal” interest framework spoken of earlier. At the same time, the other major central banks around the world are maintaining their zero or near-zero interest rate policies. The belief that even a slight uptick in interest rates can crash the world economy implies that this situation will persist for the foreseeable future.
Obviously the overall interest rate on federal debt does not respond immediately to changes in the Fed Funds rate, but since most of that debt is of less than five years maturity, it does begin to make a difference after a year or two. Even if the Fed does nothing in 2019, the average interest rate will certainly increase as bills and notes mature and are replaced with higher-coupon paper, similar to what happened in 2006-07.
In the last two years, the annual interest paid on debt held by the public has grown by $84 billion. To give you some idea of the relative size of that number, the total decrease in corporate income taxes as a result of the 2018 bill was something in the neighborhood of $ 90 billion ($ 266 billion net receipts in FY 2017 versus $ 176 billion in FY 2018). This $90 billion was proclaimed as the source of a new economic acceleration, but no economist to my knowledge has suggested that Powell’s rate increases would cause anything but a slowdown.
In any case, the ballooning interest payments resulting from a return to the pre-2008 interest-rate norm will result in the Treasury owing more than half a trillion dollars annually on debt held by the public by the time the next presidential election rolls around. Even worse, it would clearly delineate a path to accelerating deficit increases—even in good economic times—and lead to skittishness among holders of the currency. There are several ways of solving this problem, but most of them require either unpopular spending cuts/tax increases or a paradigm shift in how the national debt (and government financing and perhaps even money itself) is viewed. The simplest and least disruptive tactic would be to reduce interest rates to near-zero (as the Japanese have done). If you think the Fed is coming under pressure from the politicians now, wait until the Treasury’s interest payments really take off.
We have now reached the stage where a mere 2.5% interest rate is being blamed for tumbling asset prices and slowing economic growth. It is difficult to see a path which returns us to “normal.”
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