Traditional economic theory holds that higher central bank policy rates slow economic growth and ease inflationary pressures. That theory has been mainstream for decades if not centuries. But recent evidence suggests it is just wrong in the modern world.
A recent Bloomberg article set out the contrary theory that higher central bank rates may be fueling more rapid economic growth, at least in the short term. The headline was hard to ignore:
The article includes this chart.
As economist Thomas Sowell has said, people are not chess pieces that react in predictable ways to changes in government policies. Faced with the prospect of higher interest rates, both individuals and corporations are smart enough to lock in lower rates when those rates are artificially low (a result of the quantitative easing or QE experiment) by borrowing for longer terms in advance of a need for funds or taking out longer term fixed rate mortgages. In United States, the 30-year mortgage is the most popular and many American locked in at very low rates, insulating themselves against a cyclical rate rise.
Housing related debt is the largest portion of household debt and higher rates arising from Fed policy have less effect when muted by the mortgage lock ins. In Canada, where 30-year fixed term mortgages are unavailable, the “lock in” period was the popular 5-year fixed rate mortgage which only a few years ago had rates below 2%. About half of outstanding Canadian mortgages taken out when rates were low are the five year fixed rate variety.
People living off their credit cards are punished by higher rates in both countries and those faced with mortgage renewals at rates more than double existing mortages suffer. But looking at the economy as a whole, the interest paid to bond holders on government debt is now massive in both countries. The recent Canadian budget projects interest on the federal debt at $60 billion and the budget included a projected deficit of $40 billion, together comprising $100 billion of effective “stimulus”.
Canada has $1.8 trillion of outstanding mortgages, and approximately half or $900 billion has seen higher rates, typically up by about 3 percentage points for an aggregate drag of $27 billion impacting consumers spending, and more than offset by the effective $100 billion stimulus of the federal deficit and rapid growth in interest payments on Canada bonds. At the same time, Canadian immigration is at record levels adding to GDP growth, although manifesting itself in lower per capital GDP growth.
This scenario leads to more inflation, not less, and impacts the affordability of homes for younger Canadians some 75% of whom no longer believe they will ever own their own home. The higher rates on new mortgages and credit card balances are motivating organized labor to insist on higher wages and cost of living allowance (COLA) clauses, again fueling higher inflation.
In United States, the national debt of $34 trillion adds $340 billion of interest payments to bondholders for every percentage point rise in rates. With rates now 5 points higher than before the so-called “tightening cycle”, the higher rates comprise $1.7 trillion of “stimulus” exacerbated by federal deficits running close to another $2 trillion.
People with enough savings to hold bonds and corporations with pristine balance sheets are the beneficiaries, while ordinary Americans live paycheck to paycheck despite high employment, spending virtually all of their income to put food on the table and a roof over their heads, keeping the economy humming along at a brisk pace.
Eventually, it all breaks down. Very high rates are likely needed to restrain inflation and homes are already out of reach for many. I think reliance on Fed or Bank of Canada policy rates to curb inflation will require double digit rates as it did in the early 1980’s and the economic pain will be severe when that occurs. High unemployment is needed to lower inflation, homelessness will rise, personal and business bankruptcies will follow.
These are the outcomes of leftist “progressive” policies, harming the less fortunate in society these policies pretend were enacted for their benefit and protection.
Bidenomics and Trudeau economics are a joke and the joke is on you. Unless these toxic leaders and their supporters are run out of town in the coming elections, it will get a lot worse.