“Davidson” has been offering commentary here regarding the “Natural Rate” for ~5years now. He was the first to introduce me to the concept in detail and his analysis based on it has been nothing short of spectacular. Given Yellen and the Fed’s incessant waffling on interest rate increases, I have to say I’m inclined to go with his commentary here. Wicksell was NOT interested in ST rates. Read him here:
Yellen’s thinking of ‘Natural Rate’ is simply wrong. Wicksell’s concept of the ‘Natural Rate’ was not about short term rates. It was about the long term growth rate of an economy with current inflation as I use it. He expressly says the ‘Natural Rate’ is that over several economic cycles. He did not have the economic measures that we have today.
Charlie Munger: Invert And Use “Disconfirming Evidence”
Yellen and Bernanke act as if the ‘Natural Rate’ is the Fed Funds Rate which shows the Fed thinking misperceives the concept. The ‘Natural Rate’ is something Volker and Greenspan followed if one tracks what they did. What they did was to track T-Bill rates and adjust after-the-fact the Fed Funds Rate to be higher. Volcker kept Fed Funds ~1.0% higher while Greenspan gradually reduced Fed Funds to be about 40bps higher. The 10yr Treasury was allowed to find its own level.
When T-Bill rates gradually rose with economic/investment activity to equal the 10yr Treas rate, the credit spread becoming zero caused bank lending to stall which produced a recession. Yellen’s Fed has kept 10yr Treas rates below 2% thinking this would stimulate mtg lending. It has not because banks with the current regulatory environment cannot make loans to any but the most credit worthy. Avg FICO score for mtg loans is reported to be ~750 today when we should be seeing avg loans in the 650-700 range.
The Fed does not understand the concept of the ‘Natural Rate’.
From the WSJ:
Fed Decision Makers Wrestle With So-Called Natural Rate
Disagreement about long-term outlook leads to the writings of a long-dead Swedish expert
Updated June 12, 2016 1:10 p.m. ET
While Federal Reserve officials debate when to next raise short-term interest rates, they also are wrestling with the question of how high to lift them in coming years.
Signs point toward the new normal being much lower than in the past, which has broad implications for when the Fed should tighten monetary policy, how quickly, and how far.
Fed officials disagree about their likely end point, in part because they are struggling to understand why another underlying interest rate—the mysterious natural rate—has fallen in recent years. And for that many are turning to the musings of Knut Wicksell, a Swedish expert on the subject who died 90 years ago.
According to the textbooks, this so-called natural rate is the inflation-adjusted rate that’s consistent with the economy operating at its full potential, expanding without overheating. Also known as the equilibrium or neutral rate, it balances savings and investment.