U.S. Interest Rates Are Not Zero
Wednesday January 14, 2009
I hate to keep on picking on Paul Krugman, when there are hundreds of other well-known economists saying things that are going to look downright embarrassing five years from now. But this statement he made nearly made me throw my laptop through a wall:
Krugman's entire argument, however, depends on constant consumer rates, but for some reason he uses the Federal Funds rate as his measure of interest rates. I find this highly troubling.
Consider an increase in government spending; assume that the interest rate is fixed (a good assumption right now, because interest rates are up against the zero lower bound).Yes, the Federal Funds rate is near zero. Interest rates as a whole, are nowhere near those levels. Looking at bankrate.com the average interest rate for a 36-month new car loan in the United States is currently 7.05%, up from 6.70% last week. The interest rate on a 1 year CD is 2.47%, down from last week's 2.58%. A 30-year fixed mortgage fell 13 basis points in the last week to settle at 5.10%. I could continue on like this for hours, but you get the general idea. As Garth Brazelton has pointed out, interest rates paid by consumers and businesses have not fallen anywhere near the same degree that the Federal Funds rate has.
Krugman's entire argument, however, depends on constant consumer rates, but for some reason he uses the Federal Funds rate as his measure of interest rates. I find this highly troubling.
Comments
I don’t get that Krugman is saying that consumer interest rates are zero, only that rates can be taken as fixed given that they are near the lower bound. It is typical in physics and engineering mathematics to drop a portion of an equation as one part is so close to zero as to be negligible compared to the rest (i.e. y= 5x – .05x^2 ~ 5x). What I don’t see in his article is the equation (either explicit or fuzzy) that suggests a rate of .03 to .05 may be taken as fixed rather than variable. It would be nice if you would ferite out what leads him to this assumption so that we might better determine the impact of the assumption.
On the other hand, I have to point out that credit card interest rates, a main source of consumer credit, the one we use to buffer our month to month expenditures, can be as high at 30-40% and we might want to consider this as being the measure of consumer credit rather than CD’s and mortgage rates.
I think the point you make is valid and important. The Fed Fund rate is hardly reflective of the rate to consumers. Neither the lowered Fed rate nor the bailout money seem to find it’s way to the consumer. And with millions of individuals leveraged into their credit cards at 30% so that they could afford to pay their rent or buy shoes for their kids while still paying for gas to get to work, it does them, us and the application of economic theory a diservice to consider the Fed Fund rate.
Bailout 2008, a poem by David Jeffrey
Like a bloodied warrior,
laying broken and torn.
Like a dying soldier, hopeless and forlorn.
But the blood, it be green,
the color of money.
And the soldier is an economy,
and it is anything but funny.
Broken are it’s people and shattered are their dreams.
Thanks to the ultra rich and their full proof schemes.
It is a tragedy with more pain to come.
Finance will be Hell, and their wills will be done.