The Fate Of U.S. Interest Rates

ratesJeff D. Opdyke:  With the global economy in a tenuous spot, our Federal Reserve faces a difficult situation: Move interest rates in the wrong direction and you unleash Hell’s demons upon Asia … and you remove bulwarks buttressing our own economy.

With those words, I am not painting for you a picture of modern America.

I am, instead, recapping for you the state of affairs that confronted the Federal Reserve’s then-Chairman Alan Greenspan when he spoke to the Haas School of Business at the University of California, Berkley, in September 1998.

In that speech, Mr. Greenspan first uttered the phrase “island of prosperity” to describe what the U.S. could not afford to become in an ailing world. Doing so would clip the U.S. economy by, effectively, killing Asia. It meant that even though the U.S. itself could bear the burden of higher interest rates, the world certainly could not — and, thus, the Federal Reserve was in no position to hike rates, as so many observers were expecting.

Though the brushstrokes and details are different today, we are, in effect, staring at the same painting Mr. Greenspan saw nearly two decades ago. The U.S. cannot — and will not — raise interest rates until spring, more likely summer, of 2016.

As Janet Yellen explained in a press conference on September 17 why the Fed had decided, yet again, to leave U.S. interest rates unchanged, I was building a quick spreadsheet.

Every quarter for the past few years the Fed has published an economic update that sheds some light on what Fed governors see in our economy. I’ve dived into these numbers each quarter. They’re the reason I told my readers that the Fed would not raise interest rates until “2015 — or even 2016,” a position from which I have not deviated in more than three years.

The spreadsheet I built as Ms. Yellen dissembled shows me, unequivocally, that America is not on a path to anything remotely resembling the prosperity we once knew. We’re on a path to a new mediocre. We’re looking at a generation of subpar economic growth that has direct implications on the Fed’s road forward.

Here’s that chart:

Image for America's interest rates

In essence, the deeper we get into the recovery, the bleaker our future looks.The sadly declining lines (the blue line is the lower end of their estimate and the gold line is the upper end of the estimate) indicate that Fed governors are increasingly pessimistic about the long-run potential for the American economy. Their range of expected outcomes looking out toward and past the end of the decade has consistently decreased as this post-global-crisis “recovery” has unfolded.

That’s incongruous to all that we’re fed today by cheerful economists, sycophantic business-news reporters, the president, even many of the Federal Reserve governors themselves.

A New Lower Neutral Rate

The Fed has said over and again that it wants to get back to what it calls “neutral interest rates” — the rate at which the Fed’s interest-rate policy neither stimulates nor depresses economic growth beyond its natural pace.

A neutral rate is not expected to persist over the next year or two, but rather the rate expected to persist when the economy is growing at its long-term potential, unhindered by crises or euphoria. Economic theory going back a century holds that as potential GDP rises, so does the natural rate of interest. Conversely, then, as potential GDP declines … so does the natural interest rate.

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