High interest rates affecting economy less
The US economy's ability to post strong growth in the face of high interest rates may indicate a basic change in the way the economy operates, financial experts say.
Figures released earlier this week indicate that the gross national product (GNP) grew at a robust 9.7 percent annual rate in the first three months of the year and at a slower but still strong 5.7 percent annual rate in the second quarter. (GNP is the value of goods and services produced in the economy.)
True, higher rates helped prompt a 10.5 percent turndown in housing starts in May and contributed to flat auto sales in the first part of June. But that is not as much of a cooling as might be expected with interest rates at current levels.
According to data from Shearson Lehman/American Express Inc., commitments for 30-year, fixed-rate home mortgages are averaging 14.49 percent, and 48-month new-car loans are averaging 14.89 percent.
Mortgage rates at current levels ''historically would have killed housing,'' notes Robert Gough, senior vice-president of Data Resources Inc., a forecasting company.
The economy's recent performance leaves forecasters wondering how high interest rates will climb before the economy slows to a pace closer to 2.5 to 3 percent a year, the rate forecasters see as the maximum for long-term growth without inflation.
''Under the new rules of the financial system, we don't know what level it will take. But it will take sharply higher rates,'' says David Hale, chief economist at Kemper Financial Services Inc. Many forecasters now expect the Federal Reserve Board to tighten up on credit conditions in coming weeks.
''Recent changes in the country's financial regulation and tax system have re-equipped the economy to sustain a higher level of interest rates than in the past,'' Mr. Hale says.
As a result of the changes, ''interest rates in a period of economic expansion are forced to much higher levels - even after adjustment for inflation - than we were accustomed to seeing in the 1960s and 1970s,'' says Lyle E. Gramley, a governor of the Federal Reserve System. He spoke before the House Banking Committee recently.
''We have gone from being a relatively low interest rate society to a relatively high interest rate society,'' Yale University economist Wiliam Nordhaus said in a recent speech here.
There are several implications from the fact that it now takes higher interest rates to slow the economy. As housing and autos bear less of the burden of slowing the economy, the international sector bears more, Mr. Hale says. Rising US interest rates tend to push up the value of the dollar, making it more difficult for American exports to be sold abroad. Higher rates also make it more difficult for third-world nations to pay their loans, many of which carry adjustable interest rates.
In addition, higher interest rates cause an increasing portion of current US output to be devoted to paying debts. So, as a nation, ''our debt position is more vulnerable,'' Mr. Gough says. Individuals and companies who cannot take advantage of changes in financial regulations also may suffer.
A number of factors are at work in making the economy less sensitive to interest rates.
For one thing, interest payments always have been tax deductible. But the inflation the US has experienced since the 1970s has pushed the average taxpayer's marginal tax rate up from 20 percent then to 30 percent now. (The marginal tax rate is the rate at which the taxpayer's last dollar of income is taxed.) The result of the increase is to lower the after-tax cost of interest payments.
Then, too, the 1981 tax bill boosted corporate depreciation allowances. A depreciation allowance lets a company deduct a certain portion of an asset's value from the company's taxable income. That increases the company's after-tax cash flow and boosts the after-tax return on an asset. In turn, that lowers a company's sensitivity to the interest charged on a loan used to buy the asset.
Deregulation of the US financial markets also has played a major role in decreasing the economy's sensitivity to interest rates. In the past, the Fed could slow the economy by letting interest rates rise, prompting savers to withdraw funds from thrift institutions that were regulated as to the interest rates they could offer. That dried up lending and the resulting credit crunch slowed the economy.
But banks and thrifts now can pay market rates to attract funds. And they also have much more freedom to compete for funds. And they are also diversifying into nonbank activities that lessen their dependence on interest-sensitive activities.
One of the most important changes occurring in this era of deregulation is the increasing use of variable-rate mortgages. Banks and thrifts often offer such loans with interest rate concessions in the early years, thus reducing the short-term impact of higher rates on home buyers. Variable-rate mortgages now account for almost two-thirds of all new home loans.
Ultimately, Hale says, ''monetary restraint by the Fed can overtake financial innovation, but it will probably be at much higher levels of interest rates than were required in the past.''