Rock Hard GDP & The Federal Funds Rate

[Note: Most people will get just as much out of this post by looking at the graphs & their descriptions. However, if you're an econ buff, you'd better effin' read the whole effin' thing - or at least the "funds rate" section.]

If I don't post some Rock Hard Data, I'll be rock hard unhappy...
Fortunately for you 4ECon-readin' types, I happen to have rock hard data that, this time, doesn't really have a contrary-to-common-sense arrogance-laden agenda.

Just kidding - of course it does! However, this post is just in response to statements that some relatives of mine made not too long ago about the fact that the GDP has been falling for years because "the economy is so bad." While I know this is not a very commonly held belief (at least I assume it's not...), I still think it might be necessary to add some GDP data to the Conglomerate, just in case any future debate requires it...

...And remember - that's why it's here. If there are any questions, ask the banner at the top of the page.

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U.S. Real Quarterly Gross Domestic Product, 1947 to 2007 (Real = inflation-adjusted year 2000 dollars):


Basically, this is a graph of U.S. economic growth over the past 60 years. I'd say it looks pretty good - not too many flipper babies. Our GDP has gone from about $1.5 trillion to $11.5 trillion per year. Actually, our GDP right now is more than $13.6 trillion, but this graph shows data that adjusted all years before and after the year 2000 for inflation so we can make a better a comparison.

Now here's the same graph in terms of economic growth from one quarter to the next, from 1947 to 2007:

Remember, this graph is quarterly. I'd show you the yearly graph, but it's too boring and funky. Oh, what the hell - I'll probably get a hundred emails begging me for it, so I might as well throw it in.

Here - I spiced it up first. Now it's much more interesting:


I especially like the way the lens flare highlights the early 1970s, when stagflation was just around the corner. That's good usage of foreshadowing, if I do say so myself... And regular shadowing, too...

Now for a more recent history. I ought to answer the question that inspired this post - whether or not our recent economy has been doing very well. It has been, and the time in which it "wasn't doing so well" was not as bad as a lot of people think. That last recession we had borders on not actually being a recession due to how short it was. Here ya go:


That's 10 years worth of quarterly GDP - I highlighted the recessiony (Definition: Relating to a recession but not very recessionish) area with light red and the biggest actual decrease in quarterly GDP in dark red. Notice that the September 11th time period, did, in fact, have a relatively significant impact on the economy. (I always assumed that was one of those things people exaggerated for political reasons.) In fact, here's a breakdown of GDP growth surrounding and including September of 2001, from 1999 to 2004:


The real beginning to the recessiony time seven years ago was the third quarter of 2000. I've heard people refer to the September quarter of 2001 as the beginning of it, but it wasn't. In fact, all that was "lost" in 2001-Q3 was made up in 2001-Q4, and that was pretty much the end of the growth problems. Since then, we've been kickin' relative ass.

I figured it would be useful, somehow, for my loyal readers to have a solid grasp on our history of economic growth. All these graphs show, basically, that our economy has been chugging along and kickin' ass for a long time. While there's no guarantee the future will be absolutely golden, we've at least done pretty great up to now. In fact, let's start talking about the future...

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Rock Hard Funds Rate Data
(...Not quite discontinuous enough to deserve its own post, but enough to separate with a "post flag.")

Here's an interesting little pattern-finding game: I'm gonna put the quarterly % growth in GDP graph down here followed immediately by a history of the Federal Funds Rate from 1954 - 2007.



The bottom one is a graph of the interest rate the Federal Reserve uses to control inflation and essentially economic growth. By comparing the two graphs (I lined 'em up real nice!), we can get a very basic idea of how the economy responds to actions by the Federal Reserve. Notice that the giant spike in the middle of the bottom graph corresponds with a few of the worst quarters for economic growth in the last 30 years. Makes ya think, "High interest rate = slow growth," right? Yes, Dave, it sure does!

Notice, also, that since around 1982 quarterly GDP growth has been more consistently positive (i.e. more long periods of strong economic growth). Interestingly, that's about the time the Federal Reserve reversed the long-term direction of the funds rate. You see how the general pattern (in the bottom graph) is going up until 1982, and afterwards starts a long downward trend?

One - of many - things this represents is that we started getting more economic growth without causing inflation after 1982. If we can say that inflation occurs when the country reaches some form of capacity (As a basic example: when there are no more employees to hire, employee wages rise quickly, costs for employers goes up, then prices rise to reflect their higher costs), somehow the country increased its capacity for growth faster than ever before. Basically, if the Federal Reserve is generally lowering rates for 25 years, something big must have happened, right?

That would be, as most people probably already expected me to say, technological growth. Courtesy of automated systems, computers, databases, Speak-n-Spell, etc, the country's existing base of workers were suddenly turned into two workers each in productive ability. Know what I mean? The job of two people could "suddenly" be done by one (or thereabouts). The best thing about raising productivity, though, is that higher skilled people were paid more money, while employers made more money and were able to expand, hiring more workers of all skill levels (generally) and all the while maintaining a smart handle of their employees and their business cycles. Hence the longer periods of sustained and reasonably strong GDP growth after 1982, and why the Federal Reserve has been lowering rates instead of raising 'em, generally, for 25 years. While technological growth is not the only reason for the Fed's actions, I'd say it's the most important - although an increasingly more complex and better understanding of monetary policy helps a bit, too.

Anyways, here's something that's been punching my curiosity bone recently: The Federal Reserve recently cut the funds rate to 4.75%. While this makes sense from an "inflation targeting" standpoint, it doesn't seem to make sense in the big scheme of things. Look at the bottom graph (up there) again and imagine that our economy starts to recede: Imagine we were faced with quarterly GDP growth of almost negative 1% like we saw at the beginning of the '90s.
Dropping the funds rate to 1.00%, like we did by 2003, would this time have much less impact. It would seem, then - if you catch my drift - that economic growth might not be stimulated enough by very, very low rates, and that if productivity rates keep increasing the way they have for many years, we'll end up at a point where the funds rate has to be essentially 0.00% (like Japan's was for so many years). Of course, productivity growth is not even close to the entire reason for these statements...

Another reason I believe we might be inevitably headed for a near-zero funds rate is this: If you view the funds rate as a correlate of GDP growth (which it shouldn't be, really), you'll see that we've had a generally lowering trend of GDP growth over the past 25 years (very slight - about a .3% drop on average over this time period), but still not growing substantially, while at the same time the Fed has been lowering rates, which - you would think - should be correlated with increasing rates of growth in GDP. It's not. At the very least, GDP is staying even while rates are constantly going down (trending down, that is, over the last 25 years). As obvious as this seems from just looking at the downward trend in the funds rate since 1982, it's not technically obvious. In theory - and I bet this would be the main argument against my points - near-zero rates are enough to stimulate economic growth while targeting inflation. Where I disagree with that statement, though, is in the fact that when housing prices are facing a precipitous fall (now), a recession is possible, and inflation might not be too much of a worry considering productivity and/or population growth as well as reduced consumer demand, it seems that the long term trend in the funds rate toward 0.00% might just have to come to fruition in response to economic necessity rather than an easy, sooner-or-later it'll get there kinda thing. Basically, our economy might soon be facing a situation that will require an extremely fast drop in rates (whether or not it has anything to do with a long term trend.)

The reason why this is a problem, though, is that deflation would be something to worry about in this case. If we're getting a recession and heavy deflation AND the funds rate is already 0.00%, our Federal Reserve buddy Ben Bernanke might actually have to rent a helicopter (He once said he'd fight deflation by dropping money from a helicopter). There are other ways to fix dangerous deflation in this case, but I'd argue - and this is an extremely important point, I think - that one of the biggest, if not THE BIGGEST, problems in this scenario would be the psychological pessimism preventing investing and consumer activity. My point? Printing wads of cheap money and almost-free loans aren't going to be enough to stir people out of bed when business activity is declining and houses are still (assuming this happens in the next couple of years) overly expensive (and rapidly declining home values doesn't improve consumer sentiment...) This is just part of the story, though. It's still kind of besides the real point, so I'll have to get into "true economic growth" and its drivers some other day... My basic point is that a funds rate of zero percent and dropping money from a helicopter might not be enough (at least for some extended time period).

Another way that politicians think they can spur growth and fight a recession/deflation is by lowering taxes, or by supporting the supply-side, as they say. While the most basic idea of fighting a recession with a quick decrease in taxes and higher government spending seems to make sense on the surface, it is highly dependent on the size of the national deficit. While the main idea is to "get money to the people so they can invest/spend," when the government is giving them borrowed money, interest rates have to go up in order for the government to get the money. This - hopefully pretty obviously - could quite easily cancel out the economically helpful effects of increased government spending. Unfortunately for my dire future predictions, we are already facing huge national debt and the U.S. fiscal deficit has been hovering between $200 and $500 billion per year. This makes it kind of hard to solve economic problems with fiscal policy / increased spending (AKA reduced taxes). Funny enough, Dick Cheney recently argued with Alan Greenspan on this very issue. I'm inclined to believe Alan Greenspan. Check out the article Sr. Cheney wrote if you feel like escaping this post:

For those with a subscription:
Online WSJ: The Real Bush Record

And those without, click on this thang:













There's also a way (if not many) in which we might get an even worse scenario (or maybe less worse, I'm not positive): If the U.S. dollar falls in value (while the rest of the crap I've been spewing is occurring), we'll have pretty significant inflationary pressure (I believe, considering the nature of our economy and where we buy our materials, AKA China). If the dollar falls quite a bit, we'll end up with stagflation, where U.S. economic activity is declining while cost-push inflation (caused by product inputs, not labor inputs) is increasing. This is why I made the stagflation foreshadowing joke earlier, by the way. It seems like this scenario is very, very possible, especially considering the current direction of the dollar. Of course I could be wrong about this, or about strength of the various effects of countless different variables, but my original point still stands:

The 25-year downward trend in the funds rate suggests a possible (near-term) future deflationary situation. Whether it'll be handleable in ways I can't seem to think of is a different story. The fact is, it appears that GDP growth is staying relatively constant at ever-decreasing funds rates, and whether the cause is productivity increases, population growth (not much of it, by the way...) or a huge decades-long psychological shift in the U.S. populace, it seems to be headed to a certain point: Deflation Town. Also, while I've suggested that this may be a semi-disaster, it might not be - I'm not a econ pro, but I am inclined to think it would be a problem...

Maybe there's a PhD student somewhere who would be able to add interesting insight into all of this...