Raising Interest Rates Can’t End Well!

The Federal Reserve would like to raise target interest rates because of inflation concerns and concern that asset bubbles are forming. Part of their concern seems to arise indirectly from the rise in oil prices, relative to their low level in early 2016.

Figure 1. WSJ figure indicating likely reasons for rate hike.

A finite world does not behave the way most modelers expect. Interest rates that worked perfectly well in the past don’t necessarily work well now. Oil prices that worked perfectly well in the past don’t necessarily work well now. It seems to me that raising interest rates at this time is very ill advised.┬áThese are a few of the issues I see:

[1] The economy is now incredibly dependent upon rising debt to prop up its spending. The pattern of total debt to GDP for the United States is shown in Figure 2.

Figure 2. United States’ debt to GDP ratios based on Federal Reserve Z1 data and BEA GDP data. The red line represents the increase over the latest three years.

There was a huge increase in debt in the period leading up to the 2008 crash. Every year between 2001 and 2008, the increase in debt was greater than four times the increase in GDP. In fact, for some years in that period, more than $8 of debt were added for every dollar of GDP added.

We now seem to be starting a new run up in debt. In 2015, the amount of debt added was $2.5 trillion ($66.1 trillion minus $63.6 trillion), while the amount of GDP added was only $529 million. This indicates a ratio of over 4.7 for the single year of 2016. (Figure 2 shows only three-year averages, because of the volatility of amounts.) Continue reading