Will Lowering Interest Rates Help the Economy?

It is anticipated the US Federal Reserve will cut interest rates this week.  This is the first interest rate cut since 2008.  This cut is a reversal of the Fed’s decision to raise rates in December 2018.  When the Fed last cut rates in December 2008, the unemployment rate was 7.2%.  As of June, the US unemployment rate stood at 3.7%.  The world economy was quite different in 2008 than it is today.  So what is going on? 

As I wrote about last week, manufacturing has slowed across the globe.  But I don’t think adding more money to the system will help that problem.  I think the Fed knows that as well.  Demographics and the trade war are the leading causes of the manufacturing slowdown.  Lower interest rates can’t solve those problems.  I think the Federal Reserve knows that.

The Federal Reserve also knows that over $13 trillion in debt across the world has a negative yield.  That is not a typo.  Investors are handing money to governments and companies across the world with the expectation that they will receive less money in the future.  That blows up virtually every economic model ever created.  Most models assume capital has a cost.  All of this money has to go somewhere.  Right now, it seems like it is chasing returns in the stock market.

Currently, the US has among the highest interest rates of any developed country in the world.  Higher US rates create demand for dollars, as investors want a return on their capital.  Demand for dollars pushes up the cost for the rest of the world to buy US goods and lowers the cost for US buyers to buy foreign goods.  A certain president with a Twitter account thinks lower rates will help reverse this trend. 

That is why the Fed is cutting rates – because the rest of the world has.  Lowering rates might help the financial economy but it is going to have little to no effect on the real economy.  I hope I’m wrong.    

Sources and further reading

https://www.bls.gov/opub/ted/2009/jan/wk2/art02.htm?view_full

https://www.bls.gov/news.release/pdf/empsit.pdf

https://www.bloomberg.com/news/articles/2019-07-17/negative-yield-quicksand-risks-trapping-even-u-s-bond-market

https://www.bloomberg.com/opinion/articles/2019-07-29/negative-yields-could-be-the-death-of-bond-markets

https://www.global-rates.com/interest-rates/central-banks/central-banks.aspx

https://tradingeconomics.com/country-list/interest-rate

https://www.reuters.com/article/eurozone-bonds-germany/update-1-german-10-year-bond-yield-below-ecb-deposit-rate-for-first-time-idUSL8N2451YB

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