In part 1, a basic model of financial repression was presented. Now I apply the model to look for evidence of financial repression in the United States. First I need to give the equations of the lines.
Graph #1… Basic model of financial repression.
Path of nominal Fed rate = z * (N^2 + T^2) – (1 – z) * (N + T)
Natural real interest rate = Path of nominal natural interest rate – inflation target
Natural real GDP (N)… where e * (e – T)/(1 + T) goes to zero using regression line.
TFUR = capacity utilization * (1 – unemployment rate)
z = (2N – w + i)/(2N * (N – w +1) + w * (w – 1))
Measure of financial repression = natural real interest rate – (Fed rate – current inflation)
variables… N = Natural real GDP (80% in graph #1)… e = effective labor share (labor share index: Business sector * 0.762)… T = TFUR… w = distance that natural real interest crosses x-axis from N… i = inflation target
Is there evidence of Financial Repression in the US?
Now to apply the equations to plot a Measure of financial repression with past data. The Measure simply looks at the spread between the natural real interest rate and the current real interest rate. When the Measure of financial repression is positive, interest policy has entered the area of financial repression (highlighted blue in graph #1).
Graph #2… Evidence of financial repression in the US. (quarterly data) (constant inflation target of 2.4%.) When the line is significantly positive for many years, there is evidence of financial repression. 2% on the positive side would seem to be a common limit now.
- The line was mostly positive back in the 1960’s and 1970’s.
- Then went very negative through the 1980’s. (note: When the line goes negative (opposite of financial repression), import industries have an advantage. We saw imports surge during this period. When the line goes positive in financial repression, export industries have an advantage. I will cover this in a later post.)
- The line went positive for 3 years between 1992 and 1994m but was it high enough to be considered financial repression?
- The line went negative in 2000. Was Greenspan slowing down the economy for the presidential election?
- The line then went positive in 2004. Was Greenspan stimulating the economy for the presidential election?
- The line went negative during the crisis as the Fed rate hit the zero lower bound and couldn’t go any lower.
- Since 2011, the line has gone well positive. This is evidence that the US is currently in a monetary policy of financial repression. Is it intentional?
The Fed may not even recognize that a state of financial repression exists at the moment, because they are assuming a higher natural real GDP of an N around 78%. I assume a lower natural real GDP at an N = 74%. Jared Bernstein has published a graph showing the same low level. With the higher natural real GDP, the evidence of financial repression does not appear, because the natural real interest rate will drop for any given TFUR (composite utilization of labor and capital).
Graph #3… Evidence of financial repression does not appear if one assumes a higher natural real GDP (potential GDP).
So my view is that there is evidence of the current real interest rate being in the area of financial repression. But is financial repression expressing in the US economy? Well, tomorrow’s post explores how financial repression manifests.