What do the interest rate hikes mean?

The lack of inflation has been an issue with the Fed itself, its not a partisan issue at all.

The Fed has written quite a bit about the lack of "inflation" despite massive printing of money. Its clearly due to the abnormally low velocity of money. For example https://www.stlouisfed.org/on-the-e...elocity-tell-us-about-low-inflation-in-the-us The key segments are:

Inflation is typically described as a persistent increase in the general price level, such as in the consumer price index. One of the most important theories to explain inflation is the monetarist view that, according to Milton Friedman, “Inflation is always and everywhere a monetary phenomenon.”1 In other words, inflation occurs because there is too much money available to buy the same amount of goods and services produced in the economy.........

According to this view, inflation in the U.S. should have been about 31 percent per year between 2008 and 2013, when the money supply grew at an average pace of 33 percent per year and output grew at an average pace just below 2 percent. Why, then, has inflation remained persistently low (below 2 percent) during this period?

The issue has to do with the velocity of money, which has never been constant, as can be seen in the figure below . If for some reason the money velocity declines rapidly during an expansionary monetary policy period, it can offset the increase in money supply and even lead to deflation instead of inflation.

During the first and second quarters of 2014, the velocity of the monetary base2 was at 4.4, its slowest pace on record.

So why did the monetary base increase not cause a proportionate increase in either the general price level or GDP? The answer lies in the private sector’s dramatic increase in their willingness to hoard money instead of spend it. ​

The incredibly low velocity of money is a huge clue that there is no recovery.

Whether true inflation is 2% or 9% (as some claim by using the original CPI calculation), inflation is far below what is was expected to be (>30%).

The problem is the Fed/Treasury are gambling that when the economy really recovers and the velocity of money increases, that they can pull all that excess money out of the economy ahead of inflation, but not so early or so fast that it kills the recovery. They are guessing, they have never been very good at predicting the economy. Look at the result of QE and ZIRP - not the expected recovery they predicted, more like the opposite of what they predicted.

 

I agree on some of your points, however, I believe any economic stimulus whether interest rate or money supply ONLY WORKS when people have confidence in what our leaders are doing. And that's the rub, the American people have no confidence in Obama or his leadership.

I'm a Post-Keynesian, meaning that Keynes was misrepresented by Orthodox economics, therefore are our current problems.

Steve

 

The Fed's policies work just as long as foreign investors (AKA, suckers) play along. Price stability is comprised of two parts 1) the supply of money, and 2) the supply of commodities and manufactured goods. The Fed controls the money supply, which is the easy part, but foreign investors control a growing share of the manufactured goods component, which is the hard part.

With a paper currency fighting deflation is easy, just print more paper or add more zeros behind the numbers … fighting inflation is much harder because manufactured goods cannot just be conjured out of thin-air. The point is that over the last 35 years foreigners have been lending a great deal of help to the Fed in its fight against price inflation -- via a growing supply of the manufactured goods, which give the currency the bulk of its value. While this makes it easy for the Fed to achieve its mandates it also leaves Fed policy vulnerable to policy changes by foreign governments, and should those governments change their policies, the Fed will ultimately fail at fulfilling its mandates. Note: when price inflation is caused by a reduction in the supply of manufactured goods, this cannot be fought with rising interest rates, because that would cause greater unemployment, which would only further reduce the supply of manufactured goods.

Finally, because future conditions will make it impossible for the Fed to fulfill the mandates with which it is charged, I put forth that we should all vote to abolish the entire Federal Reserve system, to be replaced with a system which is honest and fair. Join the Resistance!

 

I don't buy the whole “velocity of money” theory. You want to know why our increasing money supply has not caused price inflation? They say a picture is worth a thousand words … so I leave you with picture of the true deflationary pressures:




Deflationary pressures will continue for as long as China (and other foreign nations) continues to INCREASE the supply of goods available for our consumption, at a rate above the rate of domestically held monetary inflation. But is this sustainable?

 

Keynes is completely misunderstood by today's politicians and seemingly by economists. Keynes claimed that during an economic downturn, the govt should deficit spend, reduce taxes, and reduce regulation, in order to get the economy moving. During the economic booms, the govt should pay down the accumulated debt, increase taxes and regulation. Keynes believed the economy could be manipulated so that the lows could be smoothed so that they would be less damaging (the highs would be smoothed as well by necessity), but he was not at all the supporter of huge, constant deficit spending government that he is made out to be.

I understand what Keynes wanted to do, I don't agree with that approach. But nobody listens to me

 

Exactly! But Keynes actually goes further to understand "uncertainty" and expectations of the future as the means for economic controls. Keynes and Roosevelt met privately about the Great Depression. No one knows what was said in the meeting but there is a story that Keynes left grumbling "he is the dumbest man I have ever met" (paraphrased). And then Roosevelt began his spending projects.

The Post-Keynesians hypothesize that Keynes was saying he needed to restore confidence in the leadership of the country and give the people greater expectations of the future. Roosevelt misunderstood.

Steve

 

She only raised the prime rate by 1 point instead of the expected 2 points. With 30 year fixed mortgages remaining relatively the same, so far, the only downside will be credit card and auto loan interest rates rising slightly, but not significantly.

 

I disagree with you that there is no recovery. From this article, it summarizes that the low velocity of money does not necessarily mean we are not in economic recovery. Given that there are very few indicators that are at an all time low simply means that the recovery is modest. The recovery is based primairly on two conflicting fiscall issues, lower tax rates and a decrease in government spending. In fact, I think that decreased in discretionary spending on the government is one of the prime factors why the money velocity is at an all time low.

 

The money velocity has dropped steadily (almost linearly) since the 3rd Quarter of 2008. The massive deficit spending in 2009, the "stimulus", the recent slight reduction in govt spending, etc, have had no impact. GDP growth has been fairly constant since 2002, with a major dip in late 2008/2009 due to the crash - in other words, pre-crash and post-crash the economy has operated about the same level. That means the drop in money velocity is real and is not a factor of govt spending.

Your link to the seeking alpha article is wrong - it assumes there is a good recovery and from there assumes the drop in money velocity does not mean a sluggish economy. There is no basis for those assumptions, they re simply put forward as truth. Even if you read the article, there are so many caveats and contradictions (such as the "the economy might still need the support of Fed's expansionary policies") that it defeats itself.

 

The two main reasons for the decline in money velocity is based on household debt and the restrictions of foreign direct investment in this country. Aiding in the decine is the contradictorily fiscal policies in play where they are offsetting each other, a decrease in discretionary government spending and a reduction of taxes on the upper income. Neither of which contribute positively or negatively to the money velocity, but more importantly to the GDP growth, or lack thereof. Continuing with austerity programs is going to mean that GDP growth will be no higher than 2% per annum. .

What this means is that money velocity is not a sign of good or bad recovery, simply the supply of money contributing to the inflation rate via CPI.

 

I agree with what you say about the unsustainability of a trade deficit.

I don't agree that fighting deflation is easy for the Fed. We have seen that is hasn't worked in the US since 7 years, and it hasn't worked in Japan for 2 decades.

However, increasing deflationary pressures by cutting federal spending, which many of the right support, would add to the deflationary pressures and make the problem worse. So, what is the solution? I don't know. I guess there is no good solution.

I fully agree with your interpretation of Keynes' ideas. I believe that he has been vilified by the right unjustifiably, because it is not understood that he proposed cutting spending in good times (meaning government spending should be anticyclic, thus acting as a low-pass filter on economic cycles).

The problem is the following: When there are actually god times, the public rallying cry is to give money back to the tax payers, i.e. tax cuts are instated. This prevents the government to pay down debt in good times. However, spending in bad times is a must, so exponentially growing debt it the consequence. Both parties are to blame equally for this.

 

In current times, tax cuts are demanded/requested during rough economic times in order to give people higher expectations of the future (economic improvement). And this often works. I really can;t think of a time it hasn't worked.

However, in reality, taxes are ALWAYS increasing with our progressive tax system. In a dynamic economy, when people earn more money, they progressively move to higher levels of the tax rate. So essentially, taxes are always increasing unless you cut tax rates now and then. Recent reports show the federal gov has been receiving the highest tax revenue ever. I think the democrats have a bigger hand in the progressive tax system than republicans.

As we have seen with Obama, the federal government has been growing by leaps and bounds during his tenure. The federal tax code is roughly 80,000 pages or so. A new entrepreneur thinks twice about entering into a new business with the current mountains of regulations and tax code, not to mention ACA. Small business has never been so burdened as it has in recent years, yet just a few years ago, small business hired roughly 70-percent of all workers in the U.S. I'm sure it's much smaller now.

Let's not forget, the labor force participation rate is at its lowest level since 1978 when many women were just entering the labor market for the first time.

Steve

 

Wrong. The velocity of money has been decreasing, the GDP growth has been constant, throughout this period which includes massive government spending, and slightly less massive govt spending. The data does not back up your claim.

Even the Fed is admitting that people and businesses are hording money because they are convinced the future is going to be bad.

 

That only proves that the velocity of money has no bearing on how the GDP is affected, by your own admission.

People hoard money because of uncertainty. Uncertainty does not mean good or bad, it mean unable to predict which way the wind is blowing. A lot of that has to do with TPP, Iran deal, tax reform, and those tax extenders. If we eliminate the uncertainty, or at least reduce the uncertainty by not cutting government spending AND not cutting taxes, that uncertainity would be reduced over time, assuming all other things remain equal.

 

Not really. In this chart, effective tax rates from 1979 to 2011 have both risen and fell for the top income beckets while the lowest income brackets have fallen generally. It is not the marginal tax rate on ordinary income since that can be offset by deduction, exemptions, and credits.

As for the labor participation rate, the reduction is based on four factors, retirement age, disability, wealth, and personal choice. The reduction does have a negative impact on SS and Medicare taxes because we have had a dwindling worker to retiree ratio since the 1950's. And with most baby boomers now starting to retire, the birth rate, or more precisely, the lack thereof, the United States is becoming more like Italy. Hence, to increase the labor participation rate, foreign workers who are subject to those SS and Medicare taxes would solve the problem, at least temporality. But for the long term, we would have to have an edict that every family must produce at least four children for a period of ten years to replenish the aging workforce.

 

We can agree to disagree. I don't think anything you said has anything to do with what I said previously. Similarly, your chart doesn't show where I mentioned tax cuts are needed to keep rates from rising. The chart doesn't show when tax cuts actually occurred. I think politics must be coloring your analysis.

Steve

 

I don't agree that regulations are what stifles the economy. As you said, the federal tax code is more than 80,000 pages. Yet, I can generate my own tax return using cheap consumer software in less than 3 hours, with absolutely NO knowledge of more than 99.9% of those 80,000 pages. And this is not a standard tax return, it includes mortgage deduction, capital gains tax, and all kinds of other deductions. So, why would a business be worse off, when they have access to much more powerful software and accountants?

No, the reason why businesses are not investing is because of lack of demand. And they have only themselves to thank for it, considering the decades-long depression of wages and competition of American labor with cheap offshored labor.

CNN just had a story that the Chinese will get an average of 10% pay raise this year? Why could that be? Because the average wage between US and China moves toward equilibration. Yet, most of the Chinese can't afford to buy the products they make, so they have to sell them to the US, until Americans also can't afford those products. We are already part way to this scenario, and the lack of demand is just a manifestation of it, as is the lack of money velocity, which was mentioned by Battle3.

 

We aren't that far apart. We just have a difference of opinion in the true nature of the problem. That "lack of demand" has a reason and that is few consumers or business owners believed in 2009 that Obama knows what he is doing and therefore won't commit themselves to high priced investment or purchases. As time goes on from 2009 and Obama is less able to make wild changes to the government then the economy slowly improves as we are seeing now.

In fact, a big global factor has been the value of the dollar. It finally strengthened, after years of falling, right before the 2014 election and remains at that level, relatively. Why do you suppose that is? (read above)

Steve

 

Uncertainty is not the issue. People can be uncertain about the specifics of the future, but if they believe the nation is on the right track and the future will be good, then they will spend money, work hard, businesses will expand. That's what happened in the several years after WW2. That's not the current situation.

If people have expectations of a declining economy, believe their children will be worse off than their parents, believe the govt is working against them, people will act accordingly. People don't need to know the exact details in order to know the situation is going to get worse. That's what's going on today.

And your examples are terrible for your argument. TPP and Iran are viewed as big mistakes which will harm the nation. The magnitude of govt spending itself is a viewed as a big mistake, and an unsustainable one. You are claiming that people will act positively and be happy if you give them certainty that those mistakes will be continued.