Where Are Interest Rates Headed Next? Insights from the Jackson Hole Symposium
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Walking the money for the rest of us. This is a personal financial on money, how IT works, how to invest IT and how to live without worrying about IT. I'm your host, David stein.

Today is episode 4 forty eight。 It's title where are interest rates headed? Next insights from the Jackson hole symposium each year in late August, just over the mountains from our cabin in idaho, the federal serve bank of canada city hosts its annual symposium in Jackson hall, wami.

This prestigious event is attended by central bankers, policymakers, academics, some investors and a few journalist. You need an invite to go. It's a highly created list.

Of course, I ve never been invited, even though not that for of a drive. The agenda is very focused. They'll discuss employment, central bank policy, financial markets, economic growth and trade. In this year's symposium, there are really six sessions or key topics that's not including for the reserve chair from pal speech or Christine laguardia unch ed and speech. She's the president of the european central bank.

The conference is kicked off by the speech by the federal serve chair and the theme on friday two day event was monetary policy and growth, and then on saturday, the theme was global trade and global financial flows. In her lunched speech, Christine, the guard quoted the danish philosopher soren kca guard, who said that life can only be understood backwards, but I must be lived forwards. The guard continued, since our policies Operate with legs, we cannot wait for the parameters of this new environment to become entirely clear.

Before we act, we have to form a view of the future and act in a forward looking away, but we will only ever truly understand the effects of our decisions after the fact. So we will have to establish new framework gear towards robust policy making. Under uncertain central bankers have to make decisions not knowing what's going to happen. It's highly uncertain. So when we think about our own investing, clearly, we don't know if what's going to happen.

We're making forward looking decisions under uncertainty, ty, including how much to invest in bonds and whether we should lock in higher rates, for example, by buying a inflation protection security right now where we can get a real yield of close to two percent over the next decade, or in two percent plus the rate inflation, that seems like a straight for a decision. But what if real rate go higher and we will feel regret because we missed out because we could have locked in interest rates even higher. Now what are these central bank policy decisions that the guard refers to? She's the head of the european and central bank.

Their policy committee is making decisions. The federal reserve open market committee is making decisions. One of their primary decisions is the level short term interest rates, what are known as the policy rate in the U. S. Is U. S. Federal fund rate. Deciding whether that rate should be higher or lower and making those changes is what is known as monetary policy, as the federal reserve and other central banks raise short term interest rates that can influence longer term rest rates because longer term, tres rates, one of the main factors is what is the consensus expectation for what the future short terminals rates will be.

For example, currently, we're seeing real rate increase and nominal interest rates increase in the us, and a primary reason rates have gone up in the last three to four months is because the consensus is the federal reserve will not be lowering its policy rate as soon as was expected three, four months ago. Short time rates will stay higher for longer, which pushed up longer term interest rates. So that's that's one policy decision central banks make what is known as monetary policy, increasing the lowering shorter magistrates.

A second policy decision that central banks can make is whether to buy or sell assets, primarily government bonds, but IT can be other assets, and this process of buying assets is known as quantitative easing. Selling those assets are letting those assets mature without buying new ones is known as quantitative tightening. We want to talk much about quantitative easing and tightening today, but surface to say quantitative easing that purchasing bonds at the same time a government runs a big budget deficit, spends more than IT takes in in tax revenue, the combination of those two things, which effectively means the central bank is monetizing the national debt, can significantly increase the money supply, the amount of cash flowing into the economy, and increasing the wealth of household.

They have more money, businesses have more money, and they spend that money, which LED to the high levels of inflation that we have today because of the big budget deficits and the quality of easing that occurred following the pandemic. Why do central banks take these policy actions either to raise or lower the policy rate to the act quantitative easing? They're trying to increase or slow down the rate of economic growth by encouraging or discouraging investment, borrowing purchases.

The idea is that if interest strates are higher, household and businesses will borrow less to buy, buy things to invest in new factories, new endeavors. Because if there's too much investment, too many purchases of cars and houses at a time, whether just isn't sufficient capacity to to produce that, there isn't enough of them that can lead to constraints, that lead to higher Prices, what will we know as inflation? Central banks also make these policy decisions to influence the rate of employment.

If unemployment is very low and wage pressures are increasing, the policy rate could be increased in order to hopefully slow the economy down, so that perhaps the desire red to hire new workers is less than some, so there's less wage pressure. In his Jackson hole speech, feder reserve chair drone pw spoke about two important targets that central banks have. The first is their inflation target.

Here's what pal set two percent is and will remain our inflation target. We are committed to achieving and sustaining a stance of monetary policy that level shorter interest rates that is sufficiently restrictive to bring inflation down to that level over time. That's the bogie.

Then they're trying to get inflation in the U. S. The consumer presented x down the two percent. That's the long term target. It's not zero because of the uncertainty as to what is the true rate of inflation.

So they wanted have A A little higher than zero so that they are not encourage deflation or following Prices, which would be basically inflation below there. The second target that central banks focus on is known as the neutral real rate of interest, our stars, another name form. And this is a rate of interest that for the policy rate.

So it's sort of figuring out what is the policy rate to ensure stable inflation and full employment, in other words, where the economy is at an equilibrate that an unobservable rate to what the ideal policy rate should be to sustainable employment and low levels of inflation, nobody really knows, and he can vary over time, pal said in his speech. We are committed to achieving and sustaining a stance of monetary policy that is sufficiently restrictive to bring inflation down to that level over time. The two percent level IT is chAllenging, of course, to know in real time when such stance has been achieved, there are some chAllenges that are common to all tightening cycles.

Tightening cycle? Is this having a high policy rate, a more restrictive policy rate, they are discouraged spending and borrowing. For example, real interest rates are now positive and well above mainstream investment of the neutral policy rate, that neutral real rate of interest, we see the current stance of policy is restrictive, putting down ward pressure on economic activity, hiring and inflation, but we cannot identify with certainty the neutral of interest, and thus there is always uncertainty about the precise level of monetary policy restraint.

The central makers don't know what the neutral real rate of interest is, is a two percent, is IT three percent, they're pretty confident, is not five percent or five and a half percent where the current feed fn rate. But because they don't know exactly where that neutral interests, they don't know how restrictive they are being. And that rate can change over time based on what's going on in the economy.

So for example, if there is greater productivity growth, so workers are becoming much more efficient and using technology, things being equal, that can lead to a higher neutral real rate of interest. If demographics are slowing, if if there is a lower birthday, if the population is aging, all things being equal, that can lead to a lower real neutral rate of interest. Both power and logged in their speeches talked about uncertainty, that there are things that central bankers and policy makers are not certain about power.

Mention that job openings in the U. S. Of declines substantially, but that hasn't LED to an increase in unemployment. He says that highly unusual, they're not exactly sure wise, but IT increases the uncertainty because suddenly something is happening that doesn't typically happen based on their models, pl said.

These uncertainties, both all the new complicate or task of balancing the risk of tightening monetary policy too much against the risk of tightening too little. Doing too little could allow above target inflation to become entrenched and ultimately require a monetary policy to ring more persistent inflation from the economy at a high cost to implement powers. Worry is that if they're not restrictive enough, that inflation could stay higher for longer.

And households and businesses, we just get used to hire inflation and start changing their behavior. And central bankers want households and businesses to be anchor to low inflation, thinking that's Normal, not that high inflation is Normal because if they get a custom behind inflation and think that's Normal, then IT becomes much more difficult to bring inflation levels down because of all the uncertainty. As investors and even central bankers, we don't know where interest rates will go from here.

We're not certain nor our central bankers when they will pause their policy rate hikes, which could put doward pressure a longer term to rates. We certainly don't know when we'll start cutting and IT IT depends on what the actual inflation numbers come in at and the employment trends IT depends on economic growth. Now there are trends that can influence what policymakers do, what central bankers are doing in the guard pointed out three in her speech that there are changes, profound changes, he said, in the labor markets and the nature of work, some workers left the the labor force following the pandemic and never returned, or workers are working fewer hours.

There's been more digitalization in terms of the manner of work, including the potential. And he mentioned potential generated ai, other technological revolutions that could destroy jobs and create new ones. And so there's a lot of uncertainty.

We talked about those teams. A second theme, SHE talked about this is ongoing energy transition to renewables from fossil fuels in the potential impact on climate change. And the third is which he calls a deep geopolitical divide.

The globe economy is into different trading blocks, is more protectionism, more trade restrictions, SHE says. Trade restrictions are up tenfold and the last decade or so, and that increases the uncertainty. Now what central banks do in terms of changing their policy rates, pursuing quantitative easing or tightening, those are tactical decisions.

They're looking at what's going on in their domestic economy and globally, they're making decisions tactically. One of the papers that was presented at the supposition is by chat severson of the university of chicago. He said, I do not have to tell anyone in this room that monetary policy, like most decisions, large and small, with economic implications, is usually an exercise in constrained optimization.

You make adjustments in an effort to get closer to the best possible outcome, given inherent limits, fundamental change in a way that necessary, tightening or loosening. And you turn the dial a bit this way or that in attempt to move things closer to the optimum, trading off various considerations, labor inflation, economic growth. He compares IT to a dial and turning IT a little bit, trying to get IT in tune the economy and all these variables, despite all the uncertainty.

And you never know if you don't even know what the neutral target is, you can't really optimize IT, but you making constant adjustments and is difficult. But let's step back, those are tactical decisions. What is the true driver of the economy? What are we trying to accomplish before we continue my pots and share some words from this weak sponsors?

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At linton. That comes lh. David. That's linked in dotcoms last David to post your job for free. Terms and conditions apply, severson said productivity growth is the only way to sustain growth in income per capital over the long run that over time, output incomes increase if each worker is able to produce more than they were before because are more fishing at IT, they get Better at IT or because of technology.

We discuss this back in episode three thirty, and upset on national wealth and well being, and I said, we can measure wealth and abundance in different ways. You could be purely growth. Domestic product is a measure of the value of output produced.

But I said, I think we recognize that life is more than just output, let's produced. We don't need to keep producing more things. We can produce fewer, Better things and focus on our well being as opposed to continually creating more and more stuff just to keep things turning along.

Recognizing we have some biosphere constraint of natural capital, the constraint of the planet, there's a difference between having let output per person and having well being our health and other basic goods that we've discussed. The most fascinating paper I read from the symposium by Charles eye Jones of stanford, and he got to really a way I had really thought about this before. We know that long term economic growth, increasing output, which hopefully leads to increasing well being, not always, is a function of how many workers we have and how productive they are.

We just saw that quote by chat severson. Productivity growth is the only way to sustain growth and income per person over the long run. But Jones gets to the heart of IT.

He says the key is ideas. He write because ideas are infinitely usable. Living standards in any country depend on the total stock of ideas that have ever been invented throughout the world.

He distinguishes between most things in the economy are what he calls rivals. We can only use one thing at a time, a computer or a barrel oil, or an hour of a surgeons time. One of the time they can be divided.

But ideas can, they're infinitely usable, is how he puts IT. He gives an example, the copa nineteen vaccine or artificial intelligence. Millions or billions of people can benefit from those things.

And so the rate of economic growth, our living standard is based on how many ideas there are that are being implement and how many new ideas have been created. He says, ideas are discovered by people. So living standards are tied to the global number of people searching for ideas.

He goes on and growth rates. This means that the growth rate of living standards in the long run depends on population growth. So we need population growth because not just others, more workers to make things and people to buy them, but so that people, entrepreneurs, s scientists, researchers come up with new ideas that can be shared across the world.

One of the chAllenges, though, is that ideas are getting more difficult to fine. It's some data to support that is, he looked at the percent of the economy that was invested in research efforts, both public and private, in intellectual property. And back in the one thousand nine and thirties, IT was about one percent of GDP.

Today at six percent of GDP. So more investment in the creation of ideas. But despite that higher investment, overall stable growth rate of the economy going back to the nineteen eighties has been about two percent per year.

In other words, the world is having to invest more in creating ideas because they are getting more difficult to find to sustain that economic growth. Because as the economy gets bigger, the amount on an absolute basis of growth you need in terms of the dollar increase in GDP not to grow through, but the dollar increase needs to be greater. Any the ideas in the way that he puts IT our stable growth rate of two percent per year has been achieved or investing an increasing share of GDP in intellectual property products.

But that exponential growth is gets more difficult because you need more, more ideas. And this is a concept we've talked about in the podcast that is difficult to keep growing, growing, growing, particularly if you have to come up with ideas that are infinitely shareable and where in the air where population growth is slowing. So there's fewer people, ultimately, there will be to create these ideas.

Now there is something, some additional trends that can hopefully generate more ideas that Jones points out this paper. One is the rise of china and india. As more more individuals get out of poverty, IT gives them more time to search for ideas that can be shared.

There's improved allocation of talent, more women in the world force coming up with more ideas. In nineteen seventy six, only four percent of inventors that receive patterns in the us. Or women, and twenty twenty IT was twelve percent.

more. Diversity leads to more ideas. And then the third element he points out is artificial intelligence. He writes, the final tail win is perhaps the most uncertain that has the greatest upside potential.

The recent emergence of ChatGPT and other large language models indicates dramatic advances in artificial intelligence machines are increasingly able to substitute for human in various task. We've argued that a lack of talented people to search for new ideas is an impediment to future growth. What if machines can replace people in this task as well? I agree with that.

In episode i've done on artificial intelligence on A I, it's that impact. I use ChatGPT all the time to help generate ideas for the podcast and other diver that are working on. Presumably other people are, and that's why it's infinitely useful. Their ideas. Another thing that leads to greater ideas is something chat server sin spoke about dynasties, the idea that a higher turnover in the labor market is people move to different companies, or as new companies are formed, that dynes m leads to greater productivity. That's what the data support, and that's what gets to this concept.

More ideas, more turn in the workforce, more turn in terms of companies, because more productive businesses, severson points out or more likely to grow and survive, and less product once are more likely to shrink and exit if governments allow that to happen. And one of the good things are good news is this dynamism seems to be increasing the last couple years coming out of the pandemic, monetary policy IT, turns out, actually influences idea creation. One of the papers presented that the Jackson hole conference was by euan mah and kasper zimmerman.

And they found that monetary policy, that level of poli, has an impact on innovation. They found a tightening shock of one percent LED to a decline in research development spending, about one to three percent, and that venture capital investment declined about twenty five percent in the next one to three years. So V, C is investing in new ideas.

Investment in R, N, D, that is also influences by the level interest rates, which is influenced by policy rates, ideas in our key at the heart of IT, what we need, but greater well being, a higher standard of living on more ideas. There is something though that put the damp on this, and this was a paper by barry icon Green and certain in arslanian, and he was tired of living with high public dead. And they pointed out that public debt have risen for both good and bad reasons.

Good reasons was macro o economic responses and to fight the pandemic, which they call financial and public health emergencies. But the bad was not reducing the debt baLance during the good economic times. And that is what's happened that would past few decades.

So since the global financial crisis back in two thousand eight, the debt, Rachel, the total public national debt to GDP has gone from forty percent to sixty percent. And we've done episode on this about the us. Their point is that's not likely to ever shrink.

In order to reduce the public debt baLanced to GDP, you need high sustained economic growth ideas. Productivity increases, population increases. It's just not likely to happen. The chAllenge of that is if I can lead to higher interest rate, a higher real rate of interest, not because productivity increasing, but just because of the sheer supply bonds that are being issued. And that's another reason real rate could be going up currently.

So when we step back and think about where are interest going, if we get more ideas, greater productivity, faster economic growth with plenty of jobs that can lead to potentially higher real rate of interest, a higher neutral rate of venture, but modest levels of inflation because there isn't the capacity constraints, because we kind of add that equal librarian. If, however, there are fewer new ideas, population shrinkage, lower productivity, slower economic growth, that would lead to lower real rates of interest, except because of the high national debt burden and the huge supply of debt, that is the brief for that could push in the opposite direction. Talk about uncertainty.

Central bankers don't know what the right level interest rates i'll be. They don't know exactly what unobservable real neutral rate of interest. And if they don't, we certainly do. So we don't really know we are going to going, but we still, just like central bankers, have to take action under uncertain. And what we can do is we can see where we are today, what is the markets temperature and that that's what we do on the podcast.

But certainly, what we do in our monthly investment conditions and strategy report on money for the restful plus and and just talking about IT and sharing what i'm doing a mp, ortons lio. One of the discussions we've been having is recently as our most recent plus episode forty, forty seven is now the time to lock in interest rates. If we have a set time horizon, we could go out and purchase a treasury inflation protection security at ten year bond and lock in two percent real rated interest plus inflation.

That's the highest real rate since two thousand and eight. I went back and looked at ten year real rate going back to two thousand. Three, the highest that I saw that IT has been during that twenty years. Time horizon is two point seven percent. Something extreme may be exceed over three percent, but the reality is we can earn two percent plus inflation by buying tips.

Currently, one reason i've bought tips in the last six months, it's perhaps the reason to take some money out of cash and put IT in to a longer term bon fund that is investing and have some of these longer term bond and locking in those higher rates. It's sort of the difference between the deciding whether to have a fixed rate mortgage where you can lock in a rate or a variable rate mortgage are exposed to changing exerted if we keep all of our bonds is sort of cash. Right now, we're exposed the potential for falling interest rates, but also keeping the optionality to invest.

If real rates go higher, I suggest finding a right baLance, having some longer term fixed income and investments, buying an individual tips, for example, for an intermediate term bond fund. Because we don't really know where rich are going, central bankers don't know. We've talked about some of the themes that could influence IT, what influences the economy, what influences interest rates.

But what we do know is where we are today. We can take action based on where we are today. That episode four, forty eight.

Thanks for listening. I have loved teaching you about investing on this podcast for over nine years. Some topics, though, I just Better explained in writing or with a chart. And that's why we have a weekly free email newsletter, the insiders guide in that newsletter, I share charts, grasp and other materials that can help you Better understand investing. It's some of the most important writing I do each week.

I spent a couple hours on that newsletter on wednesday morning as I tried to there's something that will be helpful to you if you're not on the list, please subscribe go to money for the rest of us dot com to subscribe to the free insiders guide weekly email news letter everything i've shared with you in this episode band for general education, i've not considered your specific risk situation. We've not provided investment advice. This is simply general education on money, investing in the economy. Have a great week.