It's not working! Right on cue, the plaintive cries that lower interest rates aren't working have gone out from Wall Street to Main Street via front-page newspaper stories and concerned-looking TV anchors, who don't know enough to be that concerned.
This is so predictable. In fact, it's safer to bet on predictions interest rates won't work than on the rates themselves being impotent.
In March 2000, when the NASDAQ was trading in the rarefied atmosphere above 5,000 and every loopy business idea was getting financed four times over, the commentariat was whining that higher interest rates weren't going to slow the economy.
The reason? Upstart companies have access to venture capital.
Since they don't borrow, interest rates don't matter.
That was a narrow view, to say the least. Higher interest rates curb demand and make capital investments less viable. What's more, they reduce the present value of future earnings streams.
Somehow equity analysts forgot their ABCs in their rush to gain underwriting business for their employers.
In the early 1990s, a series of 24 separate rate reductions that took the overnight federal funds rate from 9 7/8 percent to 3 percent was dismissed as "pushing on a string" -- at least until the monetary fuel kicked in.
When the Fed was trying to slow the economy in 1988, the party line was that higher interest rates weren't going to do the trick since interest income was a higher share of personal income than ever before. Hence savers would benefit from higher rates.
Wrong again. It's hard to find a situation where the central bank has not been able to engineer a rebound in economic activity with adequate monetary stimulus.
What about Japan? Doubters will point to Japan's long decade of malaise as proof positive that lower interest rates don't always do the trick. Lower interest rates are really a euphemism for stimulative monetary policy. The two don't always go hand-in-hand. When the central bank targets an interest rate, as they all do, the rate itself doesn't tell us anything about the quantity of bank reserves supplied by the central bank to keep the rate steady. The demand for credit can be weak or strong at any given overnight rate. It's that demand, and the central bank's willingness to supply whatever the banking system requires, that determines the amount of reserves supplied.
So here we are, almost six months into an aggressive rate- cutting extravaganza orchestrated by Federal Reserve Chairman Alan Greenspan, and there is still no sign that those 250 basis points of rate cuts are having any effect.
Or are they? The Index of Leading Economic Indicators posted its second monthly increase in May, the first back-to-back gain since December 1999/January 2000. The LEI started to send out consistent warning signals in the second quarter of 2000, which is when today's Armageddon forecasters were predicting 4 percent economic growth, a 7 percent funds rate and higher inflation. (At least they got one right!) The monthly LEI is widely ignored for two reasons: 1. All of the 10 components are known in one form or another by the time the index is released; and 2. If it doesn't support economists' forecasts, they ignore it.
The 0.5 percent jump in the LEI in May, the biggest increase in 17 months, was downplayed as a case of "more hope than substance" by one economist since most of the components making a positive contribution were financial-type indicators: the spread between the 10-year note and federal funds rate, the real money supply, stock prices and consumer expectations.
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