Originally Posted by bbundy
I understand the leveraging up. But I don’t understand the complexities of the correlation to interest rates. Interest rates are not set by the federal government or an administration and they are only influenced by the Federal Reserve.
I am going to simplify it a LOT, but you can think of the Federal Reserve as effectively being a fourth branch of the government, unelected but with nominated board members (similar to the Supreme Court). The Federal Reserve and the Treasury work very closely on a day-to-day basis.
Interest rates on US Treasury securities (bills, bonds, notes, etc) are directly affected by the Federal Funds Rate target (FFR, "Fed Funds"). The Federal Reserve Chairman and the Federal Open Market Committee basically say, "We are going to set the rate of really super short term lending at X%. We will buy an infinite amount of short-term paper until we drive the price to that level."
say, "We will buy $Z quadrilliondy dollars in order to drive the rate to our target price." The market knows they can, so that's where rates settle. If they really wanted to, they could skip the whole QE and Operation Twist dog and pony show and just say, "Rates on the 30-year Treasury will be 2%."
Any bond trader that tried to fight that would end up out of a job.
All longer term interest rates on US Treasury securities like the 10-year and 30-year bonds are then a function of short-term rate expectations with some minor market influences.
When interest rates rose in the late '70s and early '80s, Paul Volcker and his Federal Reserve were raising the Federal Funds Rate target to try and break price inflation.
When rates fell and stayed low in the early '00s, Greenspan and his Federal Reserve were dropping them and holding them there. When they crept up in the later half of the 2000s, Greenspan and his Federal Reserve were raising them. The central banks of countries with monetary systems like the USA, Japan, Australia, Canada, and the UK largely control the interest rate on their own sovereign bonds ("debt").
The actual transmission mechanism has changed a few times since the late '70s, but that's a super-duper simplified version.
Market forces or "the bond vigilantes" only have about a 10 - 15% influence on long-term interest rates and a less than 5% influence on shorter-term rates (as measured via correlation).
The problem is low interest rates don’t really make it any more easy for unemployed or under employed people to access it or do anything with it [...]
Yes and no. Unemployed or under employed people that are poor credit risks and/or have no demand for credit will not benefit from low interest rates. An under employed worker who is a decent credit risk or who can secure non-traditional funding (e.g. private equity or venture capital) can benefit from the low opportunity cost the lenders are facing.
Likewise, if there is enough aggregate demand for goods and services to justify it, low interest rates make it easier and cheaper for employers to grow - potentially hiring some of those unemployed workers.
That's how it works in most average business cycle recessions. That's not what we've just been through/are working through. It's a combination of a global financial crisis and a private sector balance sheet recession.
If low interest rates were the source of all the ills and bubble in the 90’s how is it that they can be so much lower now and yet the result is somewhat different.
I do not think that low interest rates in the '90s "were the source of all the ills and bubble."
I said the massive reduction of the Fiscal deficit while running a current account (aka balance of payment, aka trade) deficit was a big part of it. That is part of the understanding of sectoral balances that really belongs in the "bore you to death" thread.
Basically, while running a trade deficit, either the government sector or
the private sector can save more than they spend but not both. As the government sector became a net saver (ran a surplus), the private sector moved in to a net deficit.