Monetary Policy is Non-Linear
September 22, 2022·137 comments·In Brief
The Fed spent a decade using near-zero rates to create inflation. It didn't work. Now they're using rate hikes to fight inflation with the same certainty, ignoring that the same mechanism that failed to stimulate also can't brake until hitting a critical threshold. Everything below that point behaves differently than economic models predict.
- Central banks never reconciled a decade-long failure to generate inflation through rate cuts. Now they're deploying those same failed tools to fight inflation with complete confidence. The contradiction sits unexamined.
- At current rate levels, cash-rich corporations still hire and buy back stock. Wealthy households still purchase expensive cars and take expensive vacations. The behavior that moves inflation hasn't shifted yet because we haven't crossed the threshold.
- The inflation that needs controlling only comes from those with capital. Yet the Fed must raise rates to levels that change cash-rich behavior. Crossing that threshold means non-wealthy households face collapse. It's a paradox embedded in the mechanism itself.
- When rates finally reach the level that changes decisions among the wealthy, it's already too late for those without capital. The economic pain concentrates on those who never had access to free money. For them it won't be a recession.
- A rate level high enough to actually control inflation will feel like depression, not recession, to non-wealthy households and small businesses. And this correction is scheduled to arrive just before the 2024 election.
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Comments
The rapid rise in rates in particular mortgage rates is creating an interesting situation. If I have locked in a 3.5% 30 year mortgage, I would not want to sell my home.
Double Roosevelt with a Volcker Sandwich
Ben minces few words in today’s excellent note:
*What’s coming down the pike if the Fed raises interest rates enough to actually have an impact on inflation may well look like a “mild” recession in the aggregate macroeconomic numbers, but it will be anything but mild to corporations and households that haven’t had access to a decade of free money. It will be an outright depression. Just in time for the 2024 election.
The last 20+ years of monetary and fiscal policies have mostly favored the wealthy and big corporations. Why not pull a Constanza? With the right messenger (somebody like Fetterman?) it could be very popular and may be the only path where we aren’t torn apart. Some combination of both Roosevelt’s policies to protect the bottom 90% from the ravages of having to go Volcker:
Left with only bad choices and these may be the least bad.
What do you think?
Yes, that 3.50% 30-year fixed mortgage feels good…if you are the homeowner/borrower. But, it feels like a capital loss for the lender who now owns a very long duration asset with a coupon way under the market rate. And, it only feels good for the homeowner if they never have to find a market clearing price for their home. This is the median mortgage payment calculated on the median priced home BEFORE mortgage rates soared past 6.25% and were merely in the high 5%'s.
This further mires those without home equity on the outside looking in. But, it will snare some of the “winners” in the hot housing markets of 2021 who needed to bid 15% over ask to join the club. Because these mortgage rates will cause housing prices to fall.
For about 18 months now my wife and I have been planning and saving to buy land and build. That’s still an eventual goal, but…my rate is 3.47% and my mortgage is really low. Like, it’s <10% of our household income. It’s hard to justify trading a low rate and an easy payment for a very high rate and a ridiculous payment all in the service of having what we want.
So if I understand this correctly, Ben is saying this is the beginning of the end of the past 40 years of the financialization of our economy. Do the major benefactors of the largesse for the past 40 years understand the game is ending – assuming Mr. Powell is as resolute as he claims he’ll be? Will the powers that be admit they’re ending financialization? Which high priests will deliver that message?
Remember back when we pro-forma’d deals using 7% interest rates? Pepperidge farm remembers…
(edit and for you really old timers, yes I heard the old songs about 16% mortgages when you bought your first houses… but that was when I was born so I wasn’t doing any deals back then!)
Based on the frenzy in the institutional world to lunge into Private Equity and leveraged Private Credit while there was no return on offer in Bonds, NO! The CIO’s and family offices were trading meme stocks too, they just had them packaged in a more socially acceptable form. Will their consultants and enablers show any remorse? Also no.
The ending is ominous - the setup for ‘ A new road to Serfdom’ ?
Am guessing that EDZ3 breaking 95.5 prompted the repost of this excellent article. Fish under a frozen lake was also a head scratcher for me!
To make phase changes to the affluent-consumer economy, what’s necessary is:
The other phase changes to non-affluent consumers work via mortgage rates, car loan rates and credit card rates, and those have already shot up enough to make themselves felt.
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