Low Federal Funds Rate Was Ineffective

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by: Steven Hansen
Summary

This past week the Federal Reserve raised its Federal Funds Rate.

Many pundits warned it was illogical to raise rates when the economy was struggling.

Is the premise that there is a linkage between the Federal Funds rates and economic activity viable since the end of the Great Recession?

We all "know" there is a correlation between economic growth and the Federal Funds rate. This week the Fed raised their federal funds rate a quarter point.

It seems very logical that an economy driven by credit could be slowed and accelerated by using interest rates. When viewing credit's relationship to GDP (see graph below), this relationship worked fairly well until the Great Recession.

Even offering significantly reduced rates for consumer borrowing, it has not induced the consumer to borrow at a higher-than-the-historical norm since the Great Recession.

Of course, the Federal Funds rate used in the graphs above are not the rates the consumer or business borrows at. But even so, the credit borrowing rates most of us see are low historically - but still did not induce a spending frenzy.

Business requires a return on investment, and obviously business is not seeing a potential of much return, reflected in weak response to the historically low rates of the past several years.

There is declining growth in real estate loans, consumer loans, commercial and industrial loans. The timing to raise the Federal Funds rate is wrong - it should have been several years ago when the economy was stronger. But consider that consumers or business do not spend money for items not needed - even with low interest rates. Demand for credit is low.

I suspect that the consumer's largest monthly outlay (housing) is squeezing out discretionary spending.

It is hard to argue that the low interest rates were doing much good - the data does not support the concept that the ultra-low interest rates were supporting economic growth. Could it be that the consumer tapped out and credit is no longer a prime driver for consumer spending? It may not matter in the current environment what the interest rates are - as long as they are not too high.

My usual weekly wrap is in my instablog.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.