Friday, July 7, 2017

One Hundred Years of Federal Reserve Interest Rate Policy Explained



In this article I outline what drove the federal funds rate since WWII and what will drive it, likely through 2050.  In short, the broad inverted "V" shape of the Federal Funds Rate since WWII essentially follows a single macro trend and gyrates on this path to a secondary micro cycle.  The macro cycle is premised on the annual growth in the US adult population and the annual change in demand they represent.  The micro cycle is the business cycle, with the short term gyrations essentially following the change in full time employees.  That's it.  Not hard to be a central banker, eh?  However, for some strange reason, nearly all economists and "people in the know" focus primarily or entirely on the micro cycle?!? 

The chart below shows the macro driver, the annual change in the adult population (20-60yr/olds) growth cycle (blue line) driving the federal funds rate (black line) since WWII.  Interestingly, annual GDP growth (yellow columns) peaked from '04 through '06 and has not, nor is it likely to regain that peak based on adult population growth (which is now negative).  The only means by which annual GDP would continue to grow or surpass previous highs would be significantly more debt.  Debt at levels that would need to be considerably higher than seen since '09 against a now declining consumer base.Ok, that is the macro cycle (no PhD necessary) and below I'll make it clear which way it will continue for decades.  As for the micro cycle, each gyration can be represented by the change in full time employment (red shaded area, chart below) against the FFR (black line) this time shown against the annual change in the 25-54yr/old US population (and one glance at the declining 25-54yr/old population in the mid to late '00's should explain the great financial crisis...and why it is ongoing).If it's as simple as I suggest, then to understand the macro trend going forward, all we need to do is look at the population growth at the headwaters of the US population plus extrapolate immigration trends.  To gauge future US adult population growth, just look at current annual births plus the population capable of giving birth, the 15-40yr old population (chart below).
Couple points about the chart above,
  1. Total births from 1954 through 1964 were well in excess of 4 million annually from a child bearing population nearly half the current size. 
  2. In only one year, 2007, did the US have marginally more babies than in the previous peak of 1957 but over no five or ten year period since the baby boom of '54-->'64 has the US ever equaled or exceeded the boom...nor apparently are we likely to as the number of births continues declining since '07. 
  3. This week, the official statistics told us that the 2016 US fertility rate was the lowest in US history, and 3.94 million babies were born to a total child bearing population of 108 million.  In excess of 8% fewer total babies annually than in either '57 or '07.

This wasn't "supposed" to happen according to the Census estimates.  The chart below shows the '08 estimates and downgrades since the 2010 Census of the 0-4yr/old US population.  And it's still way too high.  Based on the updates of total births and trends through 2016, I've added what I believe the actual US 0-4yr/old population will likely look like through 2050.  Smaller than the 1960 peak, smaller than the more recent peak in 2010.  Just smaller.
And how this translates into the larger child bearing population (chart below)?  Even if I widen out to the 15-45yr/old population (assuming births continue moving to older than average mothers), the '08 Census estimate and downgrades since are still too high.  Essentially flat is far more likely.  This is based on the lower births (above) and the huge ongoing turnabout in illegal immigration since '09 (illegals are now net leaving...not coming).  America still has significant legal immigration but these sources of legal immigration have a similar or even lower birth rate than the US population at large.The changes in illegal immigration, upon which so much of the estimated growth was built, were two-fold.  One, that early '00's levels of job opportunities for low skill, low education workers would continue and that, two, once they came here, they would have significantly higher birth rates than the native population.  So wrong on both counts.  Anyway, so much for America's superior population and demographics trends allowing the US to outgrow it's problems.


So, the Fed is presently focusing on the micro cycle and hiking absolutely against the macro trend.  And, unless "this time is different", this is just another "gyration" and I suggest to you with 99.9% confidence that the Fed will be returning to the macro trend over the mid and long term.  The macro direction of interest rates premised on the population cycle is that clear (flat to down, NIRP?) and the continued negative impacts to GDP are obvious.  As for the Fed and Janet, either they are the dumbest smart people only our ivory towered academia can create...or they know quite well what I've outlined and are lying about it (for what purpose, everyone can surmise for themselves).