Interest Rates Held Far Lower Than Necessary Cause Speculative Bubbles

fig

“The Fed’s mode of operation has drastically changed over the past 12 years. Prior to 2002 the Fed would tighten monetary policy in reaction to outward signs of rising “price inflation” and loosen monetary policy in reaction to outward signs of falling “price inflation”, but beginning in 2002 the Fed became far more biased towards loose monetary policy. This bias is now so great that we are starting to wonder whether the Fed has become permanently loose.”

“The chart above comparing the Fed Funds Rate (FFR) target set by the Fed with the Future Inflation Gauge (FIG) clearly illustrates how the Fed has changed over the past two decades. Note that the Future Inflation Gauge is calculated monthly by the Economic Cycle Research Institute (ECRI) and should really be called the Future CPI Gauge, because it is designed to lead the CPI by about 11 months.”

“The chart shows that prior to 2002 the FFR tended to follow the FIG. After the FIG warned of rising “price pressures” the Fed would start hiking the FFR, and after the FIG started signaling reduced upward pressure on the CPI the Fed would start cutting the FFR. During 2002-2004, however, the Fed not only didn’t hike its targeted interest rate in response to a sharp increase in the FIG, it continued to cut the FFR. The Fed’s decision to maintain an ultra-loose stance during 2002-2004 was the fuel for the real estate investment bubble and set the stage for the collapse of 2007-2009 [in the US].” [editor’s note: The Canadian RE market was bailed out by parallel rate cuts here — before it had even crashed!]

“There was a lesson to be learned from what happened during 2002-2007, but the Fed apparently learned the wrong lesson. The lesson that should have been learned was: Don’t provide monetary fuel for bubble activities, because the eventual economic fallout will be devastating. Unfortunately, the lesson that was actually learned by the Fed was: An economic bust can be avoided forever by keeping monetary policy loose forever. The result is that the divergence between the FFR and the FIG that arose during the first half of the last decade is nothing compared to the divergence that is now in progress. Moreover, the near-zero FFR doesn’t do justice to the ‘looseness’ of the Fed’s current stance, in that 4+ years after the end of the last official recession the Fed is still pumping money as if the US were in the midst of a financial crisis.” …

“By ignoring investment bubbles and erring far more in favour of “inflation” than it has ever done in the past, the Fed is currently setting the stage for the mother-of-all economic busts.”

– from ‘Future ‘Inflation’ and Monetary Madness’, Steve Saville, 14 Oct 2013

Canadian markets are completely subservient to action in the US. (If you don’t believe this, watch any aspect of a Canadian market of any sort on a US market holiday. Flatline!)
Canadian interest rates were cut in lockstep with the US in late 2008, even though the RE market here sorely didn’t need the juicing. The BOC and the Min of Finance were, and are, at fault for dropping interest rates too far, and then holding them too low for too long.
If you want to see a graphic representation of the reason for our national RE bubble, look at the orange areas in chart below (a version of the one above). [BTW, the charts here are almost a year old.. the FIG is now back around 4, and the Fed Fund rate remains zero].
The policy is perverse, and the piper is yet to be paid.
– vreaa

fig c g

15 responses to “Interest Rates Held Far Lower Than Necessary Cause Speculative Bubbles

  1. There’s a Mexican saying about drinking tequila when you’re sick: “If it doesn’t cure you, at least it’ll make you forget”. Trouble is, the effect is both temporary and, ultimately, counterproductive.

    “Emergency” interest rates are the proverbial tequila: they make things better… until they make things worse.

  2. Bond Bubble, Stock Bubble, Commodity Bubble, Derivative Bubble, Currency Bubble, etc, etc. Interesting time we’re living in.

  3. but where do rates go from here after the inevitable crash, back up or stay in a coma ?

  4. one ring to rule them all … ? … http://tinyurl.com/n4ho5ej … pffft!

  5. El Ninja …hows Sanfrancisco… do you miss the skiing and canucks and vancouvers “tourist attractions”

    • Am loving the Bay Area — except I can’t ski and paddle board on the same day, which is a huge drawback. Lol.

      • yes not much skiing in a sub-tropical climate like SF
        how can anybody stand it there

        SF’s economy is deep, not just technology, its also Wall street West

  6. It took me a while to understand enough about zirp to know its actual effects are beyond my ken. Houses in Detroit going for cheap. Nobody wamnyts to live there despite low rates and what have you.

  7. This is poor.

    First, the “FIG”(ment?) isn’t a measurement, it’s a prediction. To the extent that it was predicting 3% inflation from 2010 through mid-2013, it’s bogus. The measure of inflation used by the Fed has been much lower. As well, the Fed has a legislated dual mandate (unemployment and inflation) and neither of them is “prevent asset bubbles.”

    I don’t argue with the likely connection between low interest rates and asset bubbles, but using some failed inflationista’s rant doesn’t buttress the case. Most angry-at-the-Fed inflationistas claim that low rates have inflated the price of everything, and are a short step away from complete goldbuggery. Telephone company stock still pays more than 5%.

    • I agree. All this really says is that whatever criteria the Fed uses to set interest rates, it was loosely correlated with FIG before 2002, but hasn’t been lately. The lesson to draw from this is that FIG is now a poor estimator for Fed actions.

      Also, it doesn’t appear that Fed actions affect FIG either.

      So, since 2002, there has been no apparent relationship between FIG and Fed actions. So how can this graph be used to make any predictions about the future of FIG or Fed actions?

      All I get from this is that when interest rates were increased around 2004-2006, it was followed by a big drop in FIG (i.e. a recession) within a few years. In contrast, the recent five years of low interest rates has no affect on FIG. Maybe the Fed was too fast to raise rates in 2004, since we have evidence that extended periods of low interest rates do not affect FIG.

  8. It is important to notice that the left axis is used to give FIG values (between 75 and 125), while the right axis is used to give the Fed fund rate (between 0 and 7), so it isn’t easy to compare these two numbers directly.

    I found another version of this graph using Google, which makes it easier to read the FIG values:
    http://www.munknee.com/inflation-what-do-the-non-cpi-inflation-gauges-say-it-is/
    This shows FIG bouncing around 100 for the last 5 years. I think this means FIG has been predicting inflation of 0% for the last 5 years. Maybe, the Fed is still using FIG; and since it predicts 0% inflation, they haven’t changed interest rates.

    This graph doesn’t show that the Fed is acting weird, it is showing that the economy is acting weird.

  9. pffft! … what? no contestants for iron chef superior metaphor soufflé? dull-dull, very dull … wackos? yes-yes, yes-yes … http://tinyurl.com/mqtgx85 … and of course … j’estare contigo cuando triste estas

  10. Whipmaster~kethwhack

    Happy Funky Funday everyone! 🙂

  11. Whipmaster~kerthwack

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