The political economy of interest rate adjustments

Interest rate adjustments are a dangerous economic tool, both when they go down too far and when they are raised too high. Central bank interest rate policies, drenched as they are in the incompetent conclusions from Keynesian macro, are about as sensible as the rest of Keynesian theory, but in any case the underlying policy seems more political than economically driven. As, for example, the Fed is raising rates right now in the midst of a bear market.

Even so, I cannot say that the effect won’t ultimately be positive, in the same way that Volker’s vast increases in rates in the first years of the Reagan presidency set up the economic recovery that followed. That may well have not been his intent, but it was the consequence. But whatever else may be the case, you may be sure that is not the intent of those whose hands are on the levers of interest rate policy at the moment. With this in mind, let me draw to your attention the following sent to me by a mate whose daily bread is earned from paying very close attention to these kinds of things.

Context, mainstream economic theory – which the fed conducts policy by – directly predicts (and it is the outright stated purpose of the policy) that raising rates is intended to slow the economy down (say, for the purpose of “combating inflation”).

Since 1981 onwards (from Reagan), there have been 62 federal reserve decisions to raise rates (i.e a deliberate policy attempt to slow the economy down), in aggregate raising rates by 46.5%.

Of those, 47 of the decisions (75.8%) were under Republican presidents, only 15 (24.1%) under Democrat. That is a ratio of ~3x more likely to be rate rises (i.e 3x more likely a deliberate policy attempt to slow the economy down) under a Republican than a Democrat.

By value terms (noting larger moves are expected to have greater impact than small moves), 82.1% of all rate rises by aggregate value have occurred under Republican presidents. That is more to 5x relative headwind/ negative policy impact (in the direction of policy intent to slow the economy down) for Republicans than what Democrats have faced.

Potential reason 1: The economy is generally stronger under Republicans due to (relative to Democrats) more pro growth policy stances. Due to that stronger underlying economy, the fed has to raise rates to slow down the growth and “control inflation” (etc etc).

Potential Reason 2: Conspiracy theory-esque political bias from the Deep State (of which the Fed is central). At one level it is just about harming electoral prospects of Republicans. At a deeper level of a deep state theory, it would be about not letting the public see the full benefits of the (relatively) freer market.

Potential Reason 3: ??? It is hard to manufacture any reason (using mainstream theory as the assumed driver of the rate rise decision) from this pattern of rate rise decisions that makes the Republicans look bad/ Democrats look good in any way…..

Note – analysis is by the rate rises only, doesn’t consider the cuts side. There has been a general bias to cuts over all presidents (except Trump).

If you would like to see a classical discussion of interest rates, you can either go back to the nineteenth century literature or you could go through Chapters 17 and 18 of the third edition of my Free Market Economics.

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10 Responses to The political economy of interest rate adjustments

  1. stackja

    If Keynes was the solution. Why is there still a problem?

  2. Adelagado

    ‘Potential reason 3 ???’ doesn’t make sense to me. (Nor perhaps to the writer. Whats are the ??? for?)

  3. Squirrel

    Sadly, the RBA is not in on the conspiracy, unless one subscribes to the view that Australian rates should be even lower. The issue here seem to be more about managing the debt bubble and avoiding a bust – good luck with that.

  4. sfw

    Steve, have you ever done a podcast on your book or other matters? If you have can you link to it? I’d be very interested.

  5. Mundi

    At least in Australia post reserve bank presidents have admitted they have no idea and all they really do is put rates up and down to maintain 2% to 3% inflation, because no fiat has failed terribly of that inflation is kept.

    I’m America however its still considered smoke and mirrors. Can’t wait to have a laugh over what Krugman has to say about the raises though.

  6. Tel

    At least in Australia post reserve bank presidents have admitted they have no idea and all they really do is put rates up and down to maintain 2% to 3% inflation, because no fiat has failed terribly of that inflation is kept.

    That’s all they can do, banking is about currency not running an economy.

    Money and banking are tools that assist a running economy, they aren’t the economy itself.

    If the USD also maintains approx 2% inflation (which is what they promise) then we just have to make sure the AUD never gets to far ahead or behind the USD, I mean how hard can that be?

    The real problem is government spending but beyond finger shaking the RBA can’t do anything about that. Hopefully the RBA doesn’t get any stupid stimulus ideas into their heads, if that happens we will really start to spiral down.

  7. Simon Colwell

    I have the 1st edition of Free Market Economics. Do I need to buy the 3rd edition?

  8. max

    “Central banking has been a corrupt, mercantilist scheme and an engine of corporate welfare from its very beginning.
    Central banking in England rose out of the British government’s demand for funds to continue King William’s War in the 1690s.
    In 1694, the British government accepted the proposal from William Paterson to establish the Bank of England; the government received its badly needed loans in return for granting special privileges to the Bank.
    The Bank of England was thus created as a way to serve the military interests of the British Empire.”

  9. Mooka

    Well our unbiased RBA raised interest rates during the Kevin 07 campaign ensuring that that complete f-wit had an easy win.

  10. flyingduk

    We all know that price fixing distorts the economy and is done only to enrich the beneficiaries. Centrally setting interest rates (as opposed to allowing the free market to do so) artificially changes the most important price in the entire economy, the rental price of money. No wonder central planning of economies doesn’t work.

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