This page has been archived and commenting is disabled.
Why the Fed Is WRONG About Interest Rates
Richard Werner – an economics professor and the creator of quantitative easing – says that it’s a myth that interest rates drive the level of economic activity. The data shows that the opposite is true: rates lag the economy.
Economics prof Steve Keen – who called the Great Recession before it happened – points out today in Forbes that the Fed’s rate dashboard is missing crucial instrumentation:
The Fed will probably hike rates 2 to 4 more times—maybe even get the rate back to 1 per cent—and then suddenly find that the economy “unexpectedly” takes a turn for the worse, and be forced to start cutting rates again.
This is because there are at least two more numbers that need to be factored in to get an adequate handle on the economy: 142 and 6—the level and the rate of change of private debt. Several other numbers matter too—the current account and the government deficit for starters—but private debt is the most significant omitted variable in The Fed’s toy model of the economy. These two numbers (shown in Figure 2) explain why the US economy is growing now, and also why it won’t keep growing for long—especially if The Fed embarks on a period of rate hiking.
Figure 2: The two key numbers The Fed is ignoring

[T]he dilemma this poses for The Fed—a dilemma about which it is blissfully unaware—is that a sustained growth rate of credit faster than GDP is needed to generate the magic numbers on which it is placing its current wager in favor of higher interest rates.
The Fed, along with all mainstream economists, dismisses this argument on the basis that the level of private debt doesn’t matter to the macroeconomy: for every debtor who can spend less because of higher rates, there is a saver who can spend more, so the two effects cancel out. This is naïve nonsense [background], because it pretends that banks don’t create money when they lend—which they do, as the Bank of England recently explained in painstaking detail—and equally, destroy it when they take in more in repayments than they pay out in new loans. So expanding bank credit adds to demand (and income and capital gains) in the economy, while contracting bank credit subtracts from demand.
With bank credit expanding at about 6% per year, total demand in the economy is expanding fast enough to give the appearance of a recovery: recorded unemployment now seems to be back to pre-crisis levels, and asset markets have boomed. But a few rate hikes over the next year will be enough to trigger a reversal in credit growth, because the level of private debt is substantially higher than it was when the last big boom began in the mid-1990s. The increased debt servicing burden will put enough debtors into distress to cause credit growth to slow down, and when it does, so will the economy.
The Fed will then be forced to do what every other bullish Central Bank has been forced to do since this crisis began: reverse direction and cut rates once more as the economy tanks, rather than returning to “Equilibrium”. It will never get back to its preferred Federal Funds rate of 4% until it learns, finally, that credit matters, and it starts to consider policies to reduce private debt to a manageable level—which is something like half its current number of 142% of GDP.
- advertisements -


Your article today in ZeroHedge http://www.zerohedge.com/news/... cites two economists that are the leading economic thinkers. These are Keen & Werner. They point out important things going on in the economy are two of three (EIR being my third one) sources I've found leading thinking today. Nice going.
Keen points out the Private (yours and mine and small/medium size business) debt. Werner (who invented the term QE) tries again to make clear that QE was supposed to go to the PRODUCTIVE SECTOR. (BTW, EIR has been saying this since the '70's.) Neither Japan or the US have followed the most obvious advice. Historically, Kennedy, FDR, Garfield, Lincoln, J.Q. Adams and WASHINGTON did follow such advice.
And, of course, this is after all, WASHINGTON'S BLOG. If Helga LaRouche had also been quoted in this fine article I could suggest that this was Hamilton and Franklin's Blog as well. Just sayin'. I don't know why we all have to pretend EIR isn't there...
Interest rates go up, I get fucked, Interest rates go down, I get fucked. Bonds go up, I get fucked. Bonds go down, I get fucked. Junk bonds go up stock market, the price of corn, gold, silver, I get fucked every time. Even when everyone is hiring I get fucked. Then I pay taxes for getting fucked, and penalties. Hmm, I guess I get fucked every time? Now that just seems UN American now don’t it? Is someone always front running me?
Front running?
Fuck NO!
They're right behind you, deep in your ass. You're being steered with each thrust.
There is no way the Fed can ever restore monetary order. It has to deal with the US government which has no ability to control spending and thus forever will demand an increasing amount of money creation. As boomers start retiring en masse it will get worse.
The fundementals will eventually require a new currency.
The Fed is doing what it thinks is right but surely knows it is mission impossible. Whether they make some tweak to interest rates is just amusement....remember Kyle Bass?...'they are just going to kill the dollar'....they will make it look like suicide.
I don't think the Fed caused this problem. Most of their actions have been in response to conditions created by the government.
As for the future...think back to 1936. If WW2 had not happened we might have started a lower standard of living back then. Anyway that is our future now. We'll have smart phones and new inventions but until the currency issue is sorted out the debt will continue to smother and real economy. Growth will remain impossible.
I agree with most of what you say except this:
"I don't think the Fed caused this problem. Most of their actions have been in response to conditions created by the government."
The Fed is allowing the problem to get worse by forcing its will on the problem.. The problem would have resolved already with out the FED.. Maybe never even materialized in the first place.. Its the distortion of power that fiat is creating that manifests itself in ways we will never know. They are playing a game of pure evil and Im not sure if they even realize it? ... By printing money they give the population enough of a cushion that they dont need to rebel. They dont have to force the needed change.. They dont have to make the powers that be listen to them. As long as they are not hungry they wont rise up... This is a power our establishment uses cunningly to remove people from the workforce peacefully without the issues of riots etc.. They are methodically ripping this country apart. One person at a time as to prevent violence.. They are very subtle and very methodical, but if you look at the way things are going in the bigger picture its obvious as Hell! Its a combo FED/GOV Hell bent on population control.
They are basically keeping everything from changing or progressing in a natural way that is beneficial to both sides. This lack of change or progression is creating more and more frustration from the populations and wont work.
"they will make it look like suicide". you mean... without blaming foreigners? monetary history would suggest otherwise
seriously, I do not know even one instance of a national currency having any kind of problems without a populistic cry with finger-pointing to some kind of evil foreigners
influxes of foreigners are done simultaneously with currency destruction by governments as a attention deflection tool. Like you are now being
I'm beginning to understand.
The lagging event is the cause of the preceeding one... just like CO2 levels and global warming.
I had it pegged when they refused to be AUDITED in, lo, these four score and many years ago...
The great delusion is of an uebermenschen at the Fed, able to make people more productive. You can only divide up what is produced. Charts and numbers impress the ignorant with mathematics. A model and system only represent reality if all external variables operate exactly as within your mathematical system.
Economics is the modern alchemy which fools the sheeple into believing and financing the neo-alchemists. The economic prophets, magicians and other charlatans are as phony as their earlier manifestations.
What Professor Keen, Janet Yellen, and just about EVERYONE ELSE is missing: The Fed has no business being in the full employment business, or the price stability business. The supposed "dual mandate" of the Fed is a nothing more than a pie-in-the-sky "dual suggestion" emanating from the toothless 1978 Humphrey Hawkins Act...which, if you take the time to read it, also "mandates" that Congress balance the budget.
We all know the old saying: if the only tool you have is a hammer, every problem looks like a nail. The Fed has two tools, both inter-related: manipulation of interest rates, and manipulation of liquidity. Unemployment inching up? Well, let's just cut some interest rates. Inflation getting a bit weak? Well, let's just pump a little liquidity into the banking system. Any success their ministrations have is anecdotal at best, and purely transitory. It's a parlor trick, nothing more.
And it is also comical, and very reminiscent of the Wizard of Oz...I can see silly little Janet, hiding behind the curtain, pulling Lever A and Lever B, smoke and fire puffing away. At least the Wizard admitted he was a fraud. Mind you, the two tools in Janet's hands are very, very powerful, but they are useless for the tasks at hand. To think that a multi-trillion dollar, dynamic, interactive worldwide economy can be "managed" by the blunt instruments of repo rates and QE...bahhhh, pure folly. It is a dangerous game they are playing, and we will all lose.
Central Banks, if they are even necessary any more in this digital age, serve only ONE legitimate function: Being the lender of last resort for solvent but illiquid banks, upon presentation of GOOD collateral, at a penalty rate of interest. Period. That's it. Alas, we are so far down the rabbit hole, that the rabbits have given up. No one, absolutely no one, can say how all this ends...but it won't be pretty.
I agree with everything you say. Also, the Fed is violating its "mandates" left and right:
of Representatives Financial Services Committee for eleven years,
assisting with oversight of the Federal Reserve, and subsequently
Professor of Public Affairs at the University of Texas at Austin – the
Fed had a hand in Watergate and arming Saddam Hussein. See this and this
including billionaire businessman H. Wayne Huizenga, billionaire
Michael Dell of Dell computer, billionaire hedge fund manager John
Paulson, billionaire private equity honcho J. Christopher Flowers, and
the wife of Morgan Stanley CEO John Mack
well, one does follow the other
In the 1980's we had interest rates in the teens and good real growth. Ever since then interest has declined. Going from zero which is clearly disfunctional to 1/4% which is only slightly better can not be wrong. This whole zero interest thing has become a total tax on savings to finance government borrowing. How people have ignored this huge tax increase is shocking. Tax increases slow the economy. Sure enough the whole world economy is slowing. The government produces bombs and such which do nobody any good at all.
If you want a world and economy with a bright future stop looking to low interest. Give the savers a reason to save and lower governemnt borrowing/tax. Stop making wars and wasting production.
Imagine a world where the FED announced they were going to let the interest rate float to whereever the market sent it. The government would be contrained to spend closer to what they actually can raise by taxation. Investors would not fund hair brain projects that have zero likely return. This whole bubble world would no longer keep real estate prices beyond the young workers who need it to form families. The whole self regulating world of free enterprise would begin to work again.
While I'm getting up there, I'm not 'up there', yet.
But I can imagine that there are a huge number of seniors that carefully saved their nest eggs for retirement just so they could live comfortably on expected normal interest rates (somewhere between 4% to 6% per year) with social security as a planned base.
What we've done for the last nine years or so, is to eviserate dad's and grandpa's retirement. We've eliminated that expected interest income and we've eliminated the expected cost of living increases in Social Security by using fucked up, made up, cooked, bogus numbers that effectively REDUCED the social security base while wiping out all of the expected interest income.
In effect, we ATE our parents and grandparents via the FED and our war criminal government.
And people like me, about ten years or so from the new expected retirement age of 67 or so, are too risk adverse to put a single dime into the market for our retirement; and my locked up 401k, which I stopped contributing to in 2007, has such limited investment opportunity that I keep in all in the guaranteed rate option (highest load and fees). Against all other investments, the one I'm in has had the lowest loss over the last eight years cumulatively. But there's no fucking way to retire on $55k. And there's no way to pull that cash to put it into something I can control.
If the market crashed a minimum of 50%, I'd consider putting some cash back into the 401-k, but only if Glass-Stegall is reinacted.
We're only seven years into the Greater Depression. We've got another 33 years to go or so. And by then I'd have hit my Zero Hedge wall...my survival is measured in less than three decades. I only wish those next (less than) 30 years weren't going to be so miserable.
The "mandates" were handed down by their partners in crime as a cover for them (the pols). Its not some (or any) banks "job" to provide employment or price/asset stawbility unless we're living in something less than a free market economy & country.
Oh wait, we are.
It's the elected political establishments JOB to implement economic policy, not some bankers. So we got some weird version of good-cop bad-cop where the pols can point at the Fed and say, bad Fed...BAD BAD Fed, elect meee! and I'll fix it!!! Give me a fucking break.
So much horsehit even the flies can't reproduce fast enough.
we eurozoners have given the ECB only one mandate: price "stawbility". not "asset stawbility", mind, that would be mostly "stawks" (or homes, as here below)
recently I was reading some interesting stuff from a "fringe economist" ranter based in Switzerland, or at least on a Swiss blog
he made a good case for all the problems of the FED being centered on asset stability... of the US housing market. he pointed at the humungous amont of "asset backed" paper the FED bought from the US banks. you know, the same securitized stuff that US banks were peddling all around the globe. at the end, all debt of private Americans for their homes, mortgages for short
he also pointed to the humungous amount of foreign assets the FED sold in order to ease this huge balance sheet transformation
he forgot to mention the one-trillion swap that the FED made with the ECB at the beginning of the crisis, and reverted afterwards. imho this one looks increasingly as a way to ease and hedge, FX-wise, this very balance sheet transformation. one stone, two birds
I personally still maintain that Americans aren't generally aware how much the US Housing markets has differed from most the rest of the world's housing markets, particularly where English is not spoken
all in all, it has been the most subsidized market ever, with a "bull run" of decades, with incredible-elsewhere mortgage rates and conditions
witness what the UK is currently attampting, with conditions made so that specifically the children of existing home-owners can afford new houses, following a political mandate of keeping new housing restricted and with prices floating up, up, up
interesting times, but with deep, deep roots, imho
These economists, the FED and goverment still haven't figured out the simplest fact of all...
No wage growth, no expansion. Less disposable income, less consuming.
Of course, one has to care about these things for it to work, thus, we conclude they are stealing us blindly and don't give a shit.
42
The answer to the question is 42.
It's the Answer to the Ultimate Question of Life, The Universe, and Everything.
And when you look at all that's going on, do we even know the questions to ask?
Who do we go after first; the banks, their owners, or their politicians?
Or do we attempt to change society first; or the financial system?
Change society ... denied.
Change the financial system ... denied.
Allowed to ask questions ... denied.
They like this system so much because it is so good for them they are never going to let it go EVER!
At the moment the only way to achieve any change is to start to support those the current lot despise = Russia, Iran, China for starters and quite a few more. Think this is already under way.