the Farmdoc daily article of December 20, 2021 postulates that U.S. federal debt is unlikely to have a major impact on federal policy and spending unless federal interest spending increases dramatically as a proportion of all federal spending. This article therefore examines nominal and real US interest rates (inflation-adjusted). Americans under 40 have little experience with sustained interest rate increases. In addition, the current real interest rate is more negative than at any time during the observation period that begins in 1962. A third article in this series will examine the US labor market.
This study uses the constant-maturity interest rate on 10-year US Treasury bonds published by the Federal Reserve Bank of St. Louis. The 10-year Treasury rate is one of the most closely watched market-determined interest rates. After increasing throughout the 1960s and 1970s, it declined steadily from a peak of 13.9% in 1981, reaching a low of 0.9% in 2020. It averaged 1.4% up to ‘now in 2021, with a recent rate of 1.43% on December 20. , 2021.
Nominal interest rates do not take inflation into account. The implicit price deflator index of gross domestic product (GDP) is considered the most comprehensive measure of prices in an economy. As measured by the year-over-year change in this index, US inflation never reached double digits, but hit at least 9% in 1974, 1975, 1980 and 1981. The initial peak What was a period of double-peaked inflation was associated with rising oil prices caused in part by an oil export embargo led largely by Middle Eastern countries. Similar to the nominal 10-year Treasury rate, inflation has fallen steadily since the early 1980s. The correlation between these two variables is +0.67, indicating a fairly close relationship in which nominal interest rates are. higher when inflation is higher. Using the average GDP price index for the first three quarters of 2021, current inflation is 3.3%, the highest since 3.4% in 1991. The GDP price index is also taken from the Federal Reserve Bank of St. Louis.
Real interest rate
The real interest rate was calculated as the 10-year Treasury constant maturity interest rate for one year less the percentage change in the implied price deflator index of GDP from the previous year. Like the nominal 10-year Treasury rate, the real 10-year Treasury rate has declined steadily since the early 1980s. The highest real interest rate was 8.8% in 1984. 10-year real interest has been negative in 5 years: 1974, 1975, 2012, 2020 and 2021. The average real rate for 2021 is currently -1.85%, the lowest since the observation period. This situation is unlikely to change once final data becomes available for 2021, as recent monthly inflation figures have remained high.
The real interest rate on 10-year US Treasuries has been negative for two years. The only other two-year period of negative real interest rates occurred in the 1970s.
The combination of inflation and negative real interest rates (1) encourages current consumption since goods and services will be more expensive in the future and (2) discourages investment in interest rate instruments such as than bank CDs since the interest earned will not cover price increases in inflation.
A key emerging question is: “Is the United States entering a period of sustained inflation?” “
What reinforces the importance of this issue is that Americans under 40 have little experience with sustained increases in inflation and interest rates. It is not known how they will react if one or both occur.
History may or may not be a good predictor of the future, but during the last bout of inflation in the United States, inflation trended upward throughout the 1960s and 1970s. is that at the end of the 1970s that the United States decided to remedy its inflation. So even though inflation is emerging as a problem, it may be several years, if not several, before the United States seriously tackles this problem. Factors that may influence the timing of a response will be the level of sustained inflation and how quickly it is rising.
The United States’ approach to tackling inflation in the late 1970s was a prolonged period of high real interest rates. This in turn led to an extended period in which federal spending on interest on debt significantly constrained federal policy and spending. It has also contributed to real estate investments, such as farmland, and stocks struggling with low returns and declining values.
The next article in this series will examine the US labor market to assess its potential impact on inflation and, by extension, interest rates.
Federal Reserve Bank of Saint-Louis. 2021, December. Federal Reserve Economic Data (FRED). https://fred.stlouisfed.org
Zulauf, C., G. Schnitkey, K. Swanson, and N. Paulson. “US Federal Debt”. farmdoc daily (11): 167, Department of Agricultural and Consumer Economics, University of Illinois at Urbana-Champaign, December 20, 2021.