Will interest rates have to go higher than inflation?

[shotgunner]

A really good article about the Federal Reserve, Paul Volcker and the period of late 70's and early 80's. It begs the question in my mind, will the Federal Reserve have to raise the prime rate so that it is higher than the inflation rate to lower inflation? Are we ready for 10%+ mortgages and car loans?

https://lawliberty.org/forum/volcke...X-vsPwU2ONILFoZJghE0Pu3Ww0_k6Gy3M_NBg-5PzoUH0

 

[DrRoy]

That was a different time, with different conditions. I seriously doubt we will get to 10%.

 

[RetireBy90]

I think rates must exceed inflation at some point. Otherwise you are still able to borrow and pay back less in inflation adjusted dollars.

What can happen is for some of the shortages, demand and other problems that are feeding inflation to diminish or go away and inflation can come down as rates rise and cross somewhere less than 8%. Fed rates should be around 4% by end of the year and we will start to see excess savings being spent causing demand to drop. I think once unemployment starts to go up to say 4.5% people will get religion and cut back on spending which can bring demand back in line or below supply. I think demand and supply imbalance is causing inflation. The biggest problem is that supply of energy and housing won't rise as much as demand has.

Just my musings

 

[MarieIG]

I think rates must exceed inflation at some point. Otherwise you are still able to borrow and pay back less in inflation adjusted dollars.

What can happen is for some of the shortages, demand and other problems that are feeding inflation to diminish or go away and inflation can come down as rates rise and cross somewhere less than 8%. Fed rates should be around 4% by end of the year and we will start to see excess savings being spent causing demand to drop. I think once unemployment starts to go up to say 4.5% people will get religion and cut back on spending which can bring demand back in line or below supply. I think demand and supply imbalance is causing inflation. The biggest problem is that supply of energy and housing won't rise as much as demand has.

Just my musings

While these are all meritorious musings, I think in addition there is another group of folks located in the DC area who need to "get religion" and moderate spending . . .

 

[MarieIG]

A really good article about the Federal Reserve, Paul Volcker and the period of late 70's and early 80's. It begs the question in my mind, will the Federal Reserve have to raise the prime rate so that it is higher than the inflation rate to lower inflation? Are we ready for 10%+ mortgages and car loans?

https://lawliberty.org/forum/volcke...X-vsPwU2ONILFoZJghE0Pu3Ww0_k6Gy3M_NBg-5PzoUH0

My hope is that as rates rise, inflation will drop and we won't "need" to go that high. When DH and I first got married, the mortgage rates were that high and higher. Guess what, we couldn't afford to buy a house (had to wait a number of years eventually saved a down payment and got a 9% mortgage) and drove beaters.

 

[RetireBy90]

PPI came out this morning still high at 8.7% year over year. PPI includes wages which impact CPI but indirectly. I wonder when I get a bump in SS in Jan and when workers go to the boss for a raise saying inflation is over 8% won't that drive inflation higher, which will drive wage demands higher. How does this stop ? Input prices drop ? Profit margins drop ?

The other concern I hear, with all the stimulus for chips and green energy, talk of all the jobs these measures will create, who will take the new jobs ? Already today we have 2 openings for every unemployed and more baby boomers falling out of job market every day how will tech step in to make workers more productive or will lower paying jobs go away ? We either need to birth more workers or allow more immigration

 

[ShokWaveRider]

Will interest rates have to go higher than inflation?

Or equal to - Hopefully Yes.

 

[Montecfo]

Well, interest rates will eventually exceed inflation. But the Fed seems to believe that inflation can fall as a result of modestly higher rates, tightening money supply and reduced supply chain issues.

We will see how that works out but the approach does not seem crazy. But they are battling spenders in Washington.

 

[Chuckanut]

A really good article about the Federal Reserve, Paul Volcker and the period of late 70's and early 80's. It begs the question in my mind, will the Federal Reserve have to raise the prime rate so that it is higher than the inflation rate to lower inflation? Are we ready for 10%+ mortgages and car loans?



https://lawliberty.org/forum/volcke...X-vsPwU2ONILFoZJghE0Pu3Ww0_k6Gy3M_NBg-5PzoUH0

I don’t recall savings rates, even long term ones, going above the inflation rate at the time the Treasury or Cd was offered. This was in the 70s and 80s.

I do recall buying a long term treasury over 10%, and a few years later with inflation now at 6 or 7% thinking that I had skillfully hit the Bonanza. Of course it was only a bit of dumb luck.

 

[shotgunner]

I don’t recall savings rates, even long term ones, going above the inflation rate at the time the Treasury or Cd was offered. This was in the 70s and 80s.

I do recall buying a long term treasury over 10%, and a few years later with inflation now at 6 or 7% thinking that I had skillfully hit the Bonanza. Of course it was only a bit of dumb luck.

Saving rates did not, but mortgages, credit cards and car loans rates did. Demand destruction comes from the cost of capital not the savings rate.

 

[marko]

I don’t recall savings rates, even long term ones, going above the inflation rate at the time the Treasury or Cd was offered. This was in the 70s and 80s.

I do recall buying a long term treasury over 10%, and a few years later with inflation now at 6 or 7% thinking that I had skillfully hit the Bonanza. Of course it was only a bit of dumb luck.

IIRC, back in the 70s you could get a long-ish term CD for nearly 15%. Of course, that was the inflation rate too but the long term aspect allowed you to outlast the inflation at that rate.

 

[Aerides]

For the better part of the past decade, we had interests rates near 1%, and inflation around 2%. So, no, interests rates do not need to be higher than inflation to hum along quite well. Things work better when they are closer.

Maybe the question (more easily answered) is, does inflation have to go lower in order to stop interest rates from rising - and most any of us can say yes to that.

Running with 10% inflation and 10% interest rates is not a healthy economy. Getting both to 2-3 would be a good balance.

 

[daylatedollarshort]

I suppose there is a first time for anything, but historically interest rates have to be higher than inflation to make saving money a better investment than spending today when inflation is running high. Like if you are thinking of getting a new car, with negative real saving rates and 8% inflation, it makes more sense to buy the car this year and save an 8% increase on the car price, instead of saving the money to make 4%. That doesn't mean rates have to go above 8%, because as the Fed raises rates the inflation rate may come down and they will meet at some lower point. Inflation seems to be pretty global right now. It may take a few major economies slamming on the brakes to make an impact.

 

[Dtail]

IIRC, back in the 70s you could get a long-ish term CD for nearly 15%. Of course, that was the inflation rate too but the long term aspect allowed you to outlast the inflation at that rate.

True, but just don't think we will see that scenario again.

 

[SnowballCamper]

From the article:

In both centuries, inflation was not an outside force attacking them, as politicians and central bankers both then and now like to portray it, but an endogenous effect of government and central bank behavior.

I see inflation as the result of the combination of high demand and excess money supply. Increasing interest rates will surely reduce demand and moderate the money supply. Rates have to go high enough to get people to reduce demand.

If I'm going to decide not to buy something today (that I have the money to purchase) I need to believe the price will be about the same in the future. With current inflation, anything I might buy, I should buy now. Otherwise I will have to pay more for it in a few months.

If interest rates get close to the inflation rate, then I could plausibly believe that my current money will grow enough that I can make the purchase in the future for the same money (since it has grown with bank interest).

So, yeah, inflation is here until interest rates exceed the inflation rate. Of course there could be some other shock to reduce demand...but would be at least as painful as high interest rates.

Let us hope the fed can thread the needle better than Volcker...

 

[Graybeard]

Didn't the 30 year treasury bond top out at 15.75% around 1985?

My 401k Stable Value fund where I was working in 1980 was 12%, no one was putting their contributions into equity funds, everyone was going into the SV fund.

I remember CDs in late 70's or early 80's were 12%.

A coworker in 1980 or 1981 got a mortgage for 21%.

 

[RetireBy90]

Well I read today that the fed’s fund rate manipulation started in 90s so we can’t look to see what Volker did. However I think Fed funds rate of 5% say by March would bring about recession and inflation would drop close to that level or lower. With inflation at 8% I’ll pay 6% on a mortgage.
I would think it isn’t what I can get,on a passbook savings account but cost of borrowing against inflation.

 

[all4j]

Someone else can likely provide more/better detail on this; & I didn't see this referenced as I skimmed the article. I believe that not long after Volcker & crew started fed action that there were also spending cuts in Congress & Reagan tax cuts. Of course, hard to quantify which affected what the most.

I believe general consensus seems to be around 1% real interest rates, but the actual magnitude/duration depends on other factors such as how late in the game it gets started.