Even though the Fed has seemingly paused its extended campaign, the recent rise in interest rates as a conscious policy effort to tame the post-pandemic inflationary spurt has much of the financialati abuzz. There are significant and complex real-world effects, to be sure—on consumers, banks, countries, companies (the whole range of borrowers and lenders) but, as is often the case, such changes in price levels and the price of money turn my mind to a historical perspective on their impact and meaning.
Some will remember the inflationary era of the late 1970s (prices increased on average 8%/year from 1972 to 1982) and the Volcker-induced spike in interest rates that killed off inflationary expectations for a generation. I bought my first house in 1983 and had a mortgage at 12ish% (the high in late 1981 was over 18%!!). Since that time, rates have pretty consistently eased down to under 3% in late 2021. It was a remarkable run. One of its implications is that few people under 60 have much experience with the idea of increasing interest rates. The current mortgage rate level (6ish%) isn’t particularly high, but it seems so.
Part of History’s job is to remind people that the difficulties of their own immediate experience is not so out of the ordinary. Short-term adjustment is often challenging, but—just as we are frustrated with non-instantaneous access to whatever website we are looking for—a little perspective can make the ‘non-ideal’ of the moment a bit more tolerable. Interest-rate-wise, we’ve had it pretty darn good for several decades. Whatever else might be said about our national economic management over the past few decades, this part has worked pretty well. We’ve avoided Japanese-like deflation and the price effects of the Great Depression of the 1930s and kept prices raising only a modest amount each year—just enough to lubricate the broader changes in the economy and prevent historical price levels from getting stuck. Since we usually demand an unreasonable degree of perfection from our policy-makers, we should at least give some kudos for this. For example, we could be in Turkey, where the recently re-elected President Erdogan has the delusion that low interest rates are the best way to fight inflation, with the result that the Turkish Lira has lost 78% of its value against the dollar in the past five years! Inflation has run as high as 85%, so it’s a great victory that it’s now only about 40%.
Of course, the idea that government (the “State”) should be responsible for the management of the economy as a whole is a relatively new one. The development of “political economy” in the 19C was an effort to bring intent and “scientific” thinking to what had been under-theorized and haphazard policies of taxation and spending up until then. One aspect of 19C liberalism was the idea that the government should invest to improve the conditions of the people as a whole (think education and infrastructure, in particular). Still, it took the Great Depression and the instigation of John Maynard Keynes to push governments to take a more active role across the economy as a whole. In combination with the rise of the “welfare state” in Europe, public expectations changed.
In the normal manner of things, people now hold their governments responsible for the overall state of their economy and such policies have become a central part of the political discussion. We all like someone to blame when things go wrong and government often fills this role. In a sense it’s too bad, because there is some evidence that 1) we don’t understand how our policies actually affect macro-economic performance in general and 2) there is a considerable portion of the economy that the government can’t do much about anyway. That’s the joy of a “private enterprise” system. In addition, it usually takes a long time for economic effects to flow for policy decisions, so any current situation is, often as not, the result of decisions made years ago.
Such subtleties are usually elided in political debates, however, where votes are more often driven by the gestalt of “are you better off now that you were four years ago?” The Biden Administration certainly hopes things calm down further over the next 16 months and that the stunning increases, for example, in supermarket prices over the past year or so will fade from the popular imagination. It’s a reflection of democratic politics that in the likely upcoming “Round 2” of geriatric Presidential debates (the uninspiring communicator with a pretty good story to tell vs. the vacuous, but effective, inspirer of millions), the memory of the price of milk will count for more than the incessant noise that passes for political campaigning these days.
From a policy perspective, too, interest rates are distinctive in this way: the popular expectation of price level changes itself contributes to those changes. It’s not just the impact of higher mortgage rates on housing prices/supply, but the fear/optimism of both past and future. Thus, managing rates requires creating not only real-world effects, but also perceptual effects in both “Wall Street” and “Main Street” (metaphorically, btw, we need a new “street,” to represent ecommerce and social media (perhaps “Net Street” or “Click Street”); it’s a tricky business, especially for underpaid civil servants.
Between overreliance on government, overconfidence in economic “science,” democratic politics in which anecdotes outweigh analysis (and both are “trumped” by polemic) and the semi-mystical mixing of policy management with popular psychology, it’s a wonder that there’s anything of coherence in all this. James Carville, managing Bill Clinton’s campaign back in 1992, famously defined their focus as “the economy, stupid.” It worked, but he should have been clearer: “It’s the public’s perception of the short-term economy, stupid.”; which is as succinct a summation of modernity as you’re likely to find.
Some will remember the inflationary era of the late 1970s (prices increased on average 8%/year from 1972 to 1982) and the Volcker-induced spike in interest rates that killed off inflationary expectations for a generation. I bought my first house in 1983 and had a mortgage at 12ish% (the high in late 1981 was over 18%!!). Since that time, rates have pretty consistently eased down to under 3% in late 2021. It was a remarkable run. One of its implications is that few people under 60 have much experience with the idea of increasing interest rates. The current mortgage rate level (6ish%) isn’t particularly high, but it seems so.
Part of History’s job is to remind people that the difficulties of their own immediate experience is not so out of the ordinary. Short-term adjustment is often challenging, but—just as we are frustrated with non-instantaneous access to whatever website we are looking for—a little perspective can make the ‘non-ideal’ of the moment a bit more tolerable. Interest-rate-wise, we’ve had it pretty darn good for several decades. Whatever else might be said about our national economic management over the past few decades, this part has worked pretty well. We’ve avoided Japanese-like deflation and the price effects of the Great Depression of the 1930s and kept prices raising only a modest amount each year—just enough to lubricate the broader changes in the economy and prevent historical price levels from getting stuck. Since we usually demand an unreasonable degree of perfection from our policy-makers, we should at least give some kudos for this. For example, we could be in Turkey, where the recently re-elected President Erdogan has the delusion that low interest rates are the best way to fight inflation, with the result that the Turkish Lira has lost 78% of its value against the dollar in the past five years! Inflation has run as high as 85%, so it’s a great victory that it’s now only about 40%.
Of course, the idea that government (the “State”) should be responsible for the management of the economy as a whole is a relatively new one. The development of “political economy” in the 19C was an effort to bring intent and “scientific” thinking to what had been under-theorized and haphazard policies of taxation and spending up until then. One aspect of 19C liberalism was the idea that the government should invest to improve the conditions of the people as a whole (think education and infrastructure, in particular). Still, it took the Great Depression and the instigation of John Maynard Keynes to push governments to take a more active role across the economy as a whole. In combination with the rise of the “welfare state” in Europe, public expectations changed.
In the normal manner of things, people now hold their governments responsible for the overall state of their economy and such policies have become a central part of the political discussion. We all like someone to blame when things go wrong and government often fills this role. In a sense it’s too bad, because there is some evidence that 1) we don’t understand how our policies actually affect macro-economic performance in general and 2) there is a considerable portion of the economy that the government can’t do much about anyway. That’s the joy of a “private enterprise” system. In addition, it usually takes a long time for economic effects to flow for policy decisions, so any current situation is, often as not, the result of decisions made years ago.
Such subtleties are usually elided in political debates, however, where votes are more often driven by the gestalt of “are you better off now that you were four years ago?” The Biden Administration certainly hopes things calm down further over the next 16 months and that the stunning increases, for example, in supermarket prices over the past year or so will fade from the popular imagination. It’s a reflection of democratic politics that in the likely upcoming “Round 2” of geriatric Presidential debates (the uninspiring communicator with a pretty good story to tell vs. the vacuous, but effective, inspirer of millions), the memory of the price of milk will count for more than the incessant noise that passes for political campaigning these days.
From a policy perspective, too, interest rates are distinctive in this way: the popular expectation of price level changes itself contributes to those changes. It’s not just the impact of higher mortgage rates on housing prices/supply, but the fear/optimism of both past and future. Thus, managing rates requires creating not only real-world effects, but also perceptual effects in both “Wall Street” and “Main Street” (metaphorically, btw, we need a new “street,” to represent ecommerce and social media (perhaps “Net Street” or “Click Street”); it’s a tricky business, especially for underpaid civil servants.
Between overreliance on government, overconfidence in economic “science,” democratic politics in which anecdotes outweigh analysis (and both are “trumped” by polemic) and the semi-mystical mixing of policy management with popular psychology, it’s a wonder that there’s anything of coherence in all this. James Carville, managing Bill Clinton’s campaign back in 1992, famously defined their focus as “the economy, stupid.” It worked, but he should have been clearer: “It’s the public’s perception of the short-term economy, stupid.”; which is as succinct a summation of modernity as you’re likely to find.
RSS Feed