Keep working so hard and so smart, and you’ll continue to pay low interest rates for a while longer.
The amazing productivity of the American worker has put a lid on interest rates, and the lid will stay on when the Federal Reserve’s rate-setting committee meets Tuesday. It is a near certainty that the federal funds rate — what banks charge one another overnight — will remain at 1 percent, and the prime rate will stay at 4 percent.
At the Chicago Board of Trade, federal funds futures traders have priced in a 96 percent chance that the Fed will keep rates steady. Traders give a 4 percent chance — or 25-to-1 odds — that the Fed will raise short-term rates by one-quarter of a percentage point, and that’s probably overstating it.
The Fed’s rate-setting Open Market Committee has done more than drop hints. The last time it met, on Sept. 16, the panel stated quite explicitly that it plans to keep rates steady “for a considerable period.” That’s as clear as the desert air. The Fed won’t raise short-term rates for months.
“The Fed has said, ‘We’re staying on the sidelines for a long time,’ so we’re going to believe that,” says Doug Duncan, chief economist for the Mortgage Bankers Association. “Our view is that that’s likely to be at least until midyear (2004), perhaps August or later, before the Fed boosts interest rates.”
Low rates help some, hurt others
That’s fine news if you plan to buy a car in the next year or so, or run up your credit card balances or draw down on your home equity line of credit. All of those types of debt are sensitive to fluctuations in short-term interest rates. Long-term mortgage rates respond to different cues, but they are expected to remain low, too. Duncan predicts that the average 30-year mortgage rate will be about 6.5 percent at the end of 2004 — not much higher than today’s rates.
On the other hand, if you’re a retiree and are being driven crazy by the persistently low rates offered on certificates of deposit, you might want to ask the younger generations to stop toiling so hard.
Interest rates are staying low as an indirect result of rising worker productivity. Productivity is a measure of the value of goods and services that workers produce over a given period, and over the past couple of years, it has been rising at an annual rate of about 4 percent. To put this in perspective, consider that productivity rose at an average annual rate of 1.5 percent from 1970 to 1995, according to Duncan.
Widgets, wages and hibernating inflation
With productivity rising so strongly, employers have less incentive to hire new employees. After all, if a typical worker made 100 widgets a week a year ago, that worker now makes 104 widgets a week. So the long jobless recovery has been extended by increases in worker productivity. As jobs remain scarce, employees don’t have much bargaining power to demand higher wages. Relatively flat wages keep inflation in hibernation, and the Fed intends to leave interest rates alone until the economy heats up enough to coax inflation from its slumber.
“Although uncertainties remain, I believe that the economic fundamentals are now in place to generate a sustainable, non-inflationary upturn,” Fed governor Susan Schmidt Bies, a member of the rate-setting committee, said at an economic conference in early October.
She and other members of the Open Market Committee, including Fed chairman Alan Greenspan, have hinted that they want to keep interest rates down until inflation picks up. And that won’t happen until millions of new jobs have been created.
Maybe next year.