Failure of Borrowing Costs to Fall: Credit Spreads v. Term Structure?

Paul Krugman adds a graph to the discussion of why borrowing cost have not declined with this commentary:

Here’s the Fed funds target rate (red line) — which is what the Fed actually controls — versus the interest rate on Baa corporate bonds (blue line), which is probably a better guide to what matters for actual business spending. It’s pretty grim. Basically, deteriorating credit conditions have offset everything the Fed has done. Doubleplus ungood.

My graph augments Paul’s graph (besides the fact that I used the effective Federal Funds rate rather than the target rate) by showing mortgage rates and interest rates on long-term (20-year) Federal bonds. I’ve been rethinking this issue a bit. First of all, mortgage rates have declined but not as much as the Federal Funds rate. But more importantly, part of the rising spread between BBB rates and the Federal Funds rate is from a rising term structure as long-term Federal bond rates have not declined as rapidly as short-term rates.

If we measure the credit spread as the difference between the BBB rate and the long-term Federal bond rate, it has increased from 1.42 percent in early July to 2.3 percent now. But this increase is not as dramatic as Paul’s graph would suggest.