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Janet Yellen’s Back-to-the-’50s Interest Rates
Janet Yellen told us last week that the fed funds target rate will be raised slightly later this year. But after that, future rate hikes will be small and gradual over the next several years. In fact, we may never have true normalization (4 percent). In my view, Yellen is offering a back-to-the-’50s approach to interest rates. And she’s right, though for many wrong reasons.
For average folks, what might this policy mean? I’ll take a guess: No boom and no bust. No inflation and no recession. All the post-war recessions were preceded by an inverted Treasury yield curve, where short rates are higher than long rates. That won’t happen for many years. Plus, upward oil-price spikes lead recessions, but we’re now in a downward energy-price cycle.
What’s the back-to-the-’50s part? Well, from Eisenhower to JFK, short rates averaged between 1 and 2 percent, inflation was roughly 1.5 percent, the dollar was tied to gold, long Treasuries ranged 2 to 3 percent, and real growth was only 2.5 percent. And despite Ike’s three recessions, the stock market roughly doubled (from very low levels).
So that was then, and this is now. Things are different. But the ultra-low interest rates are quite similar, along with low inflation and virtually stagnant real growth.
As for fiscal policy in the ’50s, the top personal tax rate was 91 percent (effectively about 70 percent) and the top corporate tax rate was over 50 percent. And the economy was heavily regulated. Sound a bit similar? It wasn’t until the’60s that JFK slashed tax rates and launched a huge economic and stock market boom. But that’s another story.
Meanwhile, why might Yellen get it right today for the wrong reasons? Well, for one, she wants higher inflation, which is a mistake. We used to think that lower inflation promoted faster economic growth. And we should be watching the value of the dollar as indicated by commodity indexes, including gold. Fortunately, the dollar is trending higher and commodities lower.
So let me say this: A sound dollar and price stability should be the Fed’s only task. But Ms. Yellen is a Phillips-curver who sees a tradeoff between inflation and growth. She obsesses about the jobs market as a Fed-tightening indicator. Wrong target. More people working does not cause inflation. Bad money does.
But Yellen is right in pointing out employment problems. We have a 5.4 percent U-3 unemployment rate, the commonly watched measure. But in this cycle, the broader U-6 measure may be closer to the truth at 10.8 percent. U-6 includes part-time people who want full-time work, discouraged people who are sometimes looking for work, and people who have left the labor force.
And when you add up U6 and U3 you get something like 16 million people out of work. And then the government’s welfare-assistance programs (including disability insurance, food stamps, and Obamacare) pay people not to work, which is a key reason why the labor-force participation rate is rock bottom at 62.8 percent and the employment-to-population ratio is only 59.3 percent. This will not be fixed by the Fed. It’s a fiscal issue of tax, regulatory, and welfare reform.
So, Yellen is right about an incomplete jobs recovery. She is also right about the lack of capital investment by businesses, where more capital would boost productivity. But that’s not the Fed’s job. The most important pro-growth policy today would be major corporate tax reform — slashing tax rates and moving to a territorial system that would bring home roughly $2 trillion stashed overseas, mostly for tax reasons. Think how much better the jobs picture would be if that money came home.
Putting that aside, the Fed is right to go slow with rate hikes. Back in the ’50s we had ultra-low interest rates for long periods of time and it was not a bad thing. The trick is to avoid Ike’s mistakes of over-taxing and over-regulating the economy.
And that brings us back to the future — namely the 2016 presidential election.
Published in Economics
Think big, Larry! Instead of slashing corporate taxes so that the left can call us greedy fat cats, let’s get congress to put in a true flat tax with the same rate for corporations and businesses. Let’s eliminate double taxation by making dividends paid to US taxpayers deductible on corporate tax returns. Then, to really blow their minds, let’s give an independent commission the authority to set the rate each year so as to balance the budget. Everyone is suddenly in the same boat. Everyone has an interest in controlling spending. The debate is now about how much a generous new spending program will raise everyone’s taxes and not just about how the government should solve this terrible new problem we just discovered.
St Augustine’s prayer: Lord, make me chaste, but not yet. Maybe in July, and gradually.
You mean an independent commission like the FCC that President Obama recently browbeat into regulating the Internet?
The Fed is trying to ignite inflation. Cross their hearts and swear to die they are trying. And the Ded has engineered long rates to historic or near historic lows.
Why on earth would a bank or a potential bond investor, looking at the two facts presented above, lend money long term? The Fed, in trying to create inflation, is actively working against your long term interest. As the saying goes…don’t fight the Fed. So if bank lending is low, capital expenditure is low, mortgage lending is low etc … Don’t wonder why.
And savers continue to get crushed.
Financial repression continues.
But they’ve been trying to get that fire started for at least six years. According to some. They’re either:
a) Not very good at it and are driving like Mr. Magoo with one foot on the accelerator and one foot on the brake (M and V in the money supply equation, Mr. Magoo chosen for the blindness that comes from the lag in stimulus and response in monetary policy) or,
b) Trying to do something else. Still like Mr. Magoo.
It may be they just like crushing small savers. Given the recent buzz on negative interest rates, I can give that credence. I think economists have been annoyed all to hell with small savers since the early 1930s, what with the bank runs and currency hoarding and all. It wasn’t the small savers fault, guys.
Down here, unlike the stratospheric view of many economists who fervently believe in top down control of the economy, it seems to me that the myriad cumulative state-created burdens have taken their toll on individuals’ incentives to innovate and produce. Six years of free money (plus whatever productivity increases have resulted from computerization of everything), resulting in minimal economic growth is evidence we may have reached a tipping point when it comes to the incentive to produce.
Progressives have largely been in charge for 100 years. Their monetary policy has given us a dollar with less than 5% of the purchasing power it had in 1913 when the Fed was birthed. Their fiscal policy has accumulated debt which would have been unbelievable a few short years ago. Part of this fiscal insanity has created large incentives for a substantial part of the population to not work at all, but rather to righteously claim an increasing share of the earnings of those who do work – and this is no longer stigmatized.
On top of the actual wealth extant lies a mountain of financial instruments (including fiat money) representing nothing more than exponentially expanding paper claims against a slow growing amount of actual wealth. As with many other trends, this is unsustainable. Monetary policy and finance have become a con game. It will work until confidence is lost. Debt is not a problem until it is. Down here, it looks to me as irresistible as gravity. Every orbit eventually decays.
I am really advocating for a balanced budget law and would not give any rate setting commission much discretion. A balanced budget mechanism and giving enough voters a direct incentive in controlling spending are the only ideas I have for bringing about fiscal responsibility. There are 18.2 trillion reasons, and counting, why we need to do something.
I think that a big part of what is holding back the economy is uncertainty over the long-term viability of the dollar itself. I know I hesitate to make any financial moves that leave me holding a bunch of dollars, even when the alternatives look wildly over-priced. Everyone I know feels the same way, and no one knows what to do about it. Balanced budgets with spending under control will lead to business confidence and a strong U.S. Dollar and a strong economy.
Any balanced budget mechanism probaby means the Supreme Court is going to make budget decisions. The SC might vote to raise our taxes, but it’s not going to make spending cuts.
Since I’ve been waiting for her to announce nominally negative interest rates, I am encouraged. I now anticipate annual rate changes of 0.0001%. As for employment, you are of course dead on that it does not belong in the Fed’s charter, and Congress should act on that to amend the Federal Reserve Act to delete the mandate for “maximum employment”.
Loved the history lesson, Mr. Kudlow, Ike’s term doesn’t seem to come up much and the next 20 years of presidents was so appalling along with the two before Ike, that they suck all of the oxygen out of the room.
I did not state my proposal clearly. Congress would delegate only one decision: what the flat tax rate is. Let Congress fulfill its budget responsibilities with the public awareness that its spending decisions directly affect how much is taken out of their paycheck. That is what is being done now. The bad affect of their decisions is just hidden in the form of stagnation, and soon, inflation.
I can tell you that since the oil price collapse, ALL new orders for durable goods process equipment are nonexistent for chemical, refining and oil/gas processing. Many orders were cancelled just before fabrication began.
My business is dead, as it is for my competitors.
A serious and interesting discussion. But I can’t help it that my first thought when I saw the post was that it’s title should be
Janet’s Yellen “Back-to-the-’50s!” for Interest Rates
I feel sorry for today’s retirees, who are simply getting zero return on their lifelong savings. It’s hard to live on the interest of your retirement accounts, when there isn’t any. I’m 66, and intend to continue working until I can’t anymore. These low interest rates are criminal.
Yellen can say whatever she wants, I won’t believe interest rates are going up until they actually do.
Check out Mike Lee’s BBA, it’s pretty airtight in preventing those types of shenanigans.