Long-term Real Fed Funds Rate: Monthly Chart Update 30/3/11

An update of the long-term real fed funds rate chart. It shows that the long-term tendency for private sector deleveraging remains in force, and that – perhaps – it is worsening.

 

The real fed funds rate is defined as the fed funds rate minus the rate of change in the consumer price index. See the chart below:

Real Fed Funds Rate (Long-term)

Click to enlarge. Source: St Louis Fed.

 

A shorter-term chart shows how the real fed funds rate is clearly pointed down sharply:

 

Real Fed Funds Rate (Short-term)

Click to enlarge. Source: St Louis Fed.

 

A brief explanation:

 

The free market is quite capable of deciding on things for itself – indeed, it is very good at doing so. However – for whatever reasons – our governments are generally intent on thwarting this natural and healthy process. This is particularly true in the business of banking; where governments and central banks tinker with the exchange ratios between central bank notes and commercial bank deposits. Central banks ‘set’ short-term rates, and attempt to ‘move’ longer-term rates (e.g. QE2).

 

But what are the unintended consequences of these actions? Well, our commercial bank deposits periodically shift from undervalued to overvalued statuses (relative to central bank notes). During periods when commercial bank deposits are undervalued; central bank notes flood into the banking-system and the money supply multiplies with the fractional-reserve lending process. Conversely, during periods where commercial bank deposits are overvalued with respect to central bank notes; central bank notes rush out of the banking-system and the money supply is forced downwards.

 

As I have mentioned before, an increasing money supply brings about generally favorable business conditions, and conversely, a decreasing money supply brings about generally unfavorable business conditions. As a rough guide, an increasing real fed funds rate is thus bullish for asset prices (as money is sucked into the banking system and multiplies). Whereas, otherwise (like now) money rushes out of the banking-system and is thus bearish for asset prices (as the fractional-reserve multiplier collapses).

See here for our collection of rare historical economic data.

Posted Mar 30, 2011