Interest Rate Obsessions & Social Costs

There’s been a lot of talk, speculation and sheer obsessional madness in the econosphere about the possibility of interest rate increases from the Fed. Yes it’s bad for markets, it’s bad for the economy, it’ll cause a recession, and all that. Noticeably absent from the obsessions though is the social costs of a rate hike. Since advanced economies can only function on credit-driven consumption, the impact to consumer credit may not only cause consumption to drop further, but will hurt a lot of people who depend on credit for their basic survival.

If there’s any doubt about the role of credit for survival, this should settle it: the changes in median income over time have not kept pace with the changes in access to consumer credit. Post 2008, that changes a bit, but only fro tightening consumer credit markets; not from drastic changes to median income.

fredgraph2

And the increase of access to credit has done a lot to gloss over income inequality as well. Just consider that with a (average of) 0.7% population increase (U.S. Census), consumer credit between 1977 and 2007 increased by 86% while median wages only increased 13.7% for the same time period (both in 2013 dollars).

fredgraph1

So where do interest rates come in? The Fed Funds rate is the gauge by which all other (consumer) interest rates are set. Traditionally, as the Fed Funds rate goes up, so does consumer credit interest rates. Also traditionally (and theoretically) as Fed Funds rates go down, so does the total revolving debt. This makes sense because prior to 2008, it’s presumed that with lower interest rates, there’s more money in the economy, and thus there isn’t a need to run high debt, even on the consumer end.

fredgraph

The opposite assumption is that as the Fed Funds rate goes up, so does consumer credit because there is less money in the economy.

Interestingly, like most correlations that were true prior to 2008, this is no longer the case. The Fed Funds rate has been so low for so long, that the use of consumer credit has started to do its own thing. Prior to 2008, the correlation between the Fed Funds rate and the total amount of revolving credit owed was 0.8 (a high correlation). Since 2008 (to present), the correlation between the Fed Funds rate and the total amount o revolving credit owed is 0.51

In other words, whether or not an interest rate hike would increase your credit card interest is about the flip of a coin. This means that as long as some institution (like a bank) is willing to make money off if interest, then credit card rates will probably go up.

So all of those folks who have been using credit for basic household consumption will have to pay more money later. Assuming a 15% interest rate on revolving credit, a gallon of gas might cost $2 now, but it will be $2.30 a year from now. That 15% is 14 times more than inflation and nearly double the rise of median income. This is just one of (no doubt many) social costs of raising interest rates.

There are arguments for raising rates. Some of them are interestingly good (such as lowering bond prices). But the real obsession should be on the fact that because median incomes are stagnant, the only the economy cannot survive without credit-driven consumption, even for non-durable goods. Households cannot meet their basic needs without credit, and there seems to be something very counterintuitive about that.

Then again, those that consume the goods and services that firms produce, households vis-à-vis the selling (or renting) of labor, has never been a great concern of central banks or the field of economics as a whole.

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This entry was posted in Economic Theory, Economics, Labor, Macroeconomics, Poverty, Public Policy, Socioeconomics. Bookmark the permalink.

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