05 April 2016
In the Keynesian imagination lowering interest rates spurs companies to increase investment and output and consumers to plunk down money on big ticket items like cars and houses.
Japan has held interest rates close to zero levels for the better part of two and a half decades and the glorious recovery, which according to theory should have happened a long time ago, is nowhere in sight. Ditto for Europe and the US, though for shorter periods.
Could the theory be wrong and do low interest rates have quite the opposite effects? The graphs below are illuminating.
The first shows corporate profits after tax for the finance and insurance industry from 1998 to 2013. There is nothing surprising about it. For the greater part of the period it shows that when interest rates are lowered financial profits go up.
The next graph is more surprising. It shows that for the greater part of the period from 1954 to 2016, manufacturing employment rises with the Fed Funds Rate and falls when the Fed Funds Rate falls.
The final two graphs illustrate the same point.
These graphs go further to establish the point we made in a previous post: that raising interest rates from very low levels helps increase the supply of loans to the real economy by making investment in financial assets unprofitable. See Higher interest rates benefit the real economy.