"Why Have Interest Rates Been So Low?"

This paper looks at interest rate developments in the US and argues that long-term real interest rates are at lows not seen in the past 50 years. It explores competing hypotheses that there is a global saving glut, there is conundrum or that global capital formation has slowed. The dominant view is a glut of saving, especially in China and Asia, that is depressing global real interest rates and boosting growth. While private sector capital formation remains at historic strong levels in the US, the same is not the case abroad. Unfortunately strong saving in China had not resulted in a boom in saving in Asia or globally. A decline in global capital formation is the proximate cause of depressed real interest rates. This is not a cyclical problem that is likely to go away with a rebound in economic activity in Asia or Europe. The implications for economic growth are dismal, despite notable exceptions in China and the US.interest rates; capital formation; saving

A report to the Federal Insurance Office

Perhaps the most important report that the FIO will ever make is the report on the system of state-based insurance regulation. By the end of January 2012, the FIO Director is to submit a report to Congress recommending changes to modernize and improve insurance regulation in the United States. This essentially means the FIO is being asked to propose its own mission and scope of operations and to lay out a road map to guide public policy decision-making moving forward in a major part of the financial services sector. Our focus here is on that report, but the discussion will also be useful in preparing other reports to the Congress mandated by DFA. This paper provides analysis and recommendations of NFI on the issues that the Congress has mandated for discussion in the FIO report to Congress early next year.Dodd-Frank Act; Federal Insurance Office; insurance regulation

U.S. Monetary Policy and Stock Prices: Should the Fed Attempt to Control Stock Prices?

This article rejects the linkages in proposals that the Federal Reserve Bank (Fed) target equity prices. The real federal funds rate (RFF) and stock prices (SP) are uncorrelated; causality tests show a positive effect of SP on RFF and a negative effect of SP on RFF. These results occur as part of the dynamics of a negative cointegrated relationship between SP and RFF. A theoretically expected inverse relation between SP and inflation accounts for the results. The negative effect of SP on FF is also confirmed in a Taylor Rule estimate. Higher stock prices anticipate lower, not higher, inflation.Monetary Policy; Bubbles; Asset Prices; Inflation.

Why Are Interest Rates So Low?

Interest rates have been unusually low in this decade. Some prominent analysts have suggested that this is due to a saving glut, especially in China. A more likely source of the lower real interest rate level is a fall in the demand for capital goods and its financing. This article looks at whether capital spending and its financing have been weak, possibly accounting for declining real interest rates. It shows that private investment has been weak by historical standards; and this has probably reflected low rates of return to global investment, as well as significant changes in the prices of capital goods relative to other goods and services. The implications of these developments are very different and also different from the excess saving hypothesis.interest rates, saving, capital formation

Predicting failure in the commercial banking industry

The ability to predict bank failure has become much more important since the mortgage foreclosure crisis began in 2007. The model proposed in this study uses proxies for the regulatory standards embodied in the so-called CAMELS rating system, as well as several local or national economic variables to produce a model that is robust enough to forecast bank failure for the entire commercial bank industry in the United States. This model is able to predict failure (survival) accurately for commercial banks during both the Savings and Loan crisis and the mortgage foreclosure crisis. Other important results include the insignificance of several factors proposed in the literature, including total assets, real price of energy, currency ratio and the interest rate spread.bank failure; banking crises; CAMELS ratings

Are High Taxes Restricting Indiana’s Growth?

The “Hoosier Comeback” program, sponsored by the Indiana Economic Development Corporation, is part of a strategy to boost economic growth, in this case through increasing the quantity and quality of available human resources by providing subsidies to encourage the return of former residents. Whether emigration rates could be boosted more by cuts in income tax rates or by cuts in the corporate, sales or property taxes is an open issue, but the taxes that have risen most in recent years have been sales and property taxes. The Tax Foundation’s State Business Climate Index suggests that more bang would come from cutting the individual income tax. Economic theory would also suggest that cutting taxes on corporate capital income, or property (structures) would have the largest efficiency gains because the underlying resources are the most mobile.Tax rates and migration; tax policy and growth

Business Investment, Cycles and Tax Policy: Are We Investing Too Little?

Some analysts have argued that bubble excesses of the late-1990s led to excessive real investment, and that an important consequence was that capital formation has been depressed since then, as firms have let production catch up with the excessive capital stock. While this description broadly fits the pattern of business fixed investment from the mid-1990s at least until 2003, it may be overstated. The business cycle and tax policy have played more important roles in explaining the pattern of investment activity. The resumption of investment, so long as tax policy changes in 2003 are maintained, suggests the excess capacity argument is no longer valid, if it ever was.Tax policy and investment; business cycle and investment

Is Your Bubble About to Burst?

House prices have risen quite sharply since 2000. Coming on the heels of a stock market crash, many analysts have raised the specter of collapse in house prices and have conjured up dire consequences from such a collapse. This article examines the extent of the house price rise, whether there are factors that account for it, whether prices are likely to collapse, and if they did, the macroeconomic consequences of such a decline. It suggests that the rise in prices was due to fundamental economic changes, especially a decline in real interest rates. A sharp decline in the national average price is unprecedented, but national prices have declined slowly relative to other goods and services, not by falling, but rather by failing to rise as rapidly as other prices. This has happened twice in the last twenty-five years and is likely to be the pattern in coming years, if prices return to some past average relationship. Finally the article discusses the economic consequences of a house price collapse and argues that the recessionary implications of a price bust would be minimal. There are three main potential channels of influence, a banking sector crisis due to mortgage defaults, a decline in consumer spending as households attempt to rebuild wealth, and a decline in home building in response to diminished sales. The article argues that none of these possibilities are likely, even in the unlikely event of a major price collapse.asset price bubble; house prices; wealth effects

The Superlative Recession and economic policies

In late 2008 and early 2009, there has been a serious deterioration in the economic outlook of political leaders, the media and many economic analysts. Comparisons of recent performance and the outlook have degenerated into comparisons with the Great Depression of the 1930s, suggesting that the current recession is the worst since the 1930s. This recession should be called the superlative recession because discussions invariably refer to the most dismal performance since the Great Depression. These superlative comparisons are far off base. But more importantly, the superlatives seem to have succeeded in reversing 70 years of history on economic policy and economic thought. With the benefit of time, depression era policies had been seen as complete failures that extended and worsened the depression. A long delayed monetary policy easing has offered new possibilities for an end to the deepening recession, but its continuation remains in doubt because it is the result of a shift in policy procedures more than of a shift in policy. More troublesome is that massive fiscal policy programs have become central to the policy debate, despite three large failed fiscal responses over the past year and a strong consensus in the policy community that such efforts are not likely to be effective. A change of leadership has focused efforts on increasing federal spending in ways and to an extent not seen in many years, comparable with the fall 2008 explosion in money growth and putting fiscal policy in the same superlative response category as the recession itself.recession; monetary policy; fiscal policy

A New Plan for Growing Indiana’s Income

The Indiana Economic Development Corporation (IEDC) released a new economic development plan, Accelerating Growth, on April 25, 2006, which has as its primary aim or “vision” to boost the state’s personal income per capita to the national average by 2020. To accomplish this, the IEDC outlines numerous steps to improve capital formation, largely by various and sundry traditional spending and tax incentives, as well as a few more novel programs that take the government into new areas of intervention in economic activity. The focus here is on clarifying the importance and achievability of the plan’s goal rather than the specifics of how it might be attempted.Growth and income objectives