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.


googleheim said...

for image 1 there is an inverse relationship.

can i ask a question - before getting off the gold standard, was gold a commodity that was as freely traded in markets with ETF's, funds, etc ?

probably not.

since we are off the gold standard, gold has found it's place in the markets of the real economy instead and not inside the federal reserve or fort knox.

the gold standard is the USD and not the other way around.

can you explain the gold standard fixations from the same neolib austrians ?

googleheim said...

MMT crediting and federal reserve operations are not similar to Alchemical dreams of turning lead ( Pb ) to gold.

This is what neolibs are getting just as backwards when saying that all this "printing" is happening

they are all in the think that this is alchemy ...

mike norman said...


Prior to 1971 the gold price was fixed, so it really didn't trade per se.

Regarding the Austrians, I really can't explain anything they say.

googleheim said...

The point is that the Ron Paulistos want to get back on the gold standard and that means putting the gold back in the Reserve and take it off the markets.

It cannot work. It's like going back to using DDT to spray children's playgrounds.

How do you take gold off the markets ? you cann't

anyway Krugman's picture of Debt to GDP from Australia ( best ) to Greece ( worst ) explains the rigging of the currency market

why is the Australian dollar near the USD, meanwhile Euro is higher and yen is higher while Japan is off the graph from Greece ??

Райчо Марков said...

Nicely done job, Mike, thank you!

Tom Hickey said...

Most Austrians equate inflation with "increase in money stock."

Tom Hickey said...

"they are all in the think that this is alchemy ..." = they don't have clue about monetary operations.

Anonymous said...

Yes, Goog, there is an inverse relationship in chart 1, which is entirely consistent with MMT. Deficits drive Interest Rates down

googleheim said...


how did in the 80's volcker CPR the economy with 18% interest rates ( obviously to get savings rates up )
while at same time Reagan outspent all previous administrations combined ?

Anonymous said...

I do not know the state of US trade & unemployment situation at the time so cannot say but Warren Mosler would tell you that Volcker tried to control the money supply whereas MMTers recognise the money supply is endogenous.

Matt Franko said...


Required reading for Gasparino, O'Donnell, and Asman.

Suggest next time you're on, see if Fox can do an injection of these images for you as you make this point, if seeing is believing then these are very powerful images...


Tom Hickey said...

g : how did in the 80's volcker CPR the economy with 18% interest rates ( obviously to get savings rates up )
while at same time Reagan outspent all previous administrations combined ?

"Deficits don't matter."

Sheldon Ridge said...

Mike, Great job on Fox slapping down Charlie Gasparino. You made him look foolish on this subject. He could not understand that there is no correlation with rates and deficeit.

Chewitup said...

Correct me if I'm wrong. The Austrians regard von Mises as their Jesus. Human Action Is their bible. That is all well and good on a micro level. In a commodity based economy, ie gold, controlling the supply of money will control inflation, but wreaks havoc on booms and busts (especially when someone has a monopoly on your supply of energy).

Now you decide to issue your own currency and it so happens that it can be exchanged freely with other currencies at a floating rate. You now have the ability to spend any amount you need to, as long as you have the resources, productivity and output to back it up. If the economy slows down, you have the ability to heat it up. If the economy gets too hot, you have the ability to temper it. You just have to decide how many people are going to get their underwear in a bunch when you "spend" or "tax" too much, and how you will deal with said people.

The problem lies with the issue of faith. How do you change what people feel in their gut? No one wants to find out that Jesus doesn't have it right anymore. On a optimistic note, there are many Doubting Thomases out there who may be searching for a new faith. The other problem is no one wants to be proselytized. They need to discover it on their own.

That being said, I have become an apostle and am trying to spread the MMT gospel according to Mike.

Tom Hickey said...

There are Austrians that integrate MMT, like Edward Harrison, at