Wednesday, March 30, 2011
Gov't spending, deficits, inflation and long-term rates. The truth, once and for all.
We've been told by the neoliberal-Austrian-hard-money-fiscal-conservatism propaganda crowd that we must fear excessive government spending and debt because that will inevitably lead to skyrocketing and crushing interest rates. It's a "given" we're told, pretty much.
Yet once again a simple analysis of past history reveals the TRUTH--that there is no such correlation between government spending and deficits and interest rates. In fact, there is even weak correlation between inflation and interest rates as I will show. The only real thing that we can see, quite clearly in fact, is that long term interest rates are anchored by Fed policy and nothing more.
At this point those of you who are familiar with MMT and how the Fed uses monetary operations to set interest rates, please feel free to shout the phrase, "Duh!!!"
That's right...because long term interest rates are nothing more than the expectation of Fed policy over the term in question and if rates have been set lower for the past 30 years (despite exponentially rising gov't spending, deficits and even fluctuating inflation), long-term rates will trend lower.
Please examine the following charts:
Chart 1. Government spending vs Long-term interest rates
Absolutely zero correlation between government spending, which rose nearly 10-fold in the past 30 years, and long-term rates, which went down 73% over the period.
Chart 2. Surplus/Deficits vs Long-term interest rates
This chart is pretty clear: long-term rates have continued to come down despite a humongous surge in the deficit.
Chart 3. Inflation rates vs long-term interest rates
I would say the relationship between inflation and long-term rates, at least by looking at this chart, is suspect. Rates did drop sharply along with a concomitant decline in inflation from 1980 to 1986, however, inflation has since hovered in the 2% to 4% zone while long rates have continued to decline.
Chart 4. Fed funds vs long-term interest rates
We can quite clearly see a very strong correlation between the central bank's overnight interest rate target (Fed funds) and long-term yields. And why not? As stated before the long-term yield simply reflects Fed interest rate policy over the term.