So I make my first expedition in time out of mind to Donald Luskin's website. What do I find there? I discover that he is very unhappy because a bunch of people (of which I am one) have been worrying that real interest rates have been "too volatile" recently.
What do we mean by "too volatile"? Well, we think that real interest rates should be determined by Federal Reserve policy and by opportunities for profitable investment produced by expectations of economic growth, and that nominal interest rates should equal real interest rates plus expected inflation. And we are worried because it looks as though recent large and volatile swings in interest rates have been driven not by changes in Fed policy, expectations of investment opportunities, growth, and inflation, but rather by "technical" factors in the bond market--specifically, the endogenous and poorly-understood duration of mortgage-backed securities.
And a financial market that is feeding the rest of the economy the "wrong" prices--prices that don't accurately indicate fundamentals but are distorted by technical factors, noise, and bubbles--is not doing its job, and is leading the rest of us to make mistakes about where to allocate productive resources.
How does Luskin respond to this worry? First, he accuses New York Times writer and fellow worrier Gretchen Morgenson of plagiarism. Second, he accuses her of a desire to nationalize all of Wall Street. Third, he says that what we worry about simply didn't happen: there were no recent large and volatile swings in interest rates. There were swings in bond yields, but bond yields are not interest rates:
The Conspiracy to Keep You Poor and Stupid: ...However mortgage rates and Treasury rates are determined, neither of them are interest rates... they are both nothing more than the yields of particular securities that reflect interest rates... as stocks, and... everything else... reflects interest rates.... Interest rates are an abstraction. They are, by definition, the opportunity cost of money across time...
I had never before imagined that anybody would ever try to draw a distinction between a yield on a bond and an "interest rate." I have no idea what such a distinction might be, any more than I have an idea how one might distinguish between cane sugar and C12H22O11...Posted by DeLong at August 18, 2003 02:30 PM | TrackBack