The Fed’s flow of funds data released last week go a long way toward explaining why rates have stayed so low so long. The standard explanation focuses on the uber-stimulative monetary policies–very low fed funds targets and quantitative easing. But, if this were a typical cyclical recovery/expansion, those policies would, by now, have encouraged strong private-sector borrowing, a consequent rapid growth in the money supply and, possibly, a significant increase in inflation. That, in fact was what was being predicted nine or ten years ago by those who were screaming that the Fed was printing money. In fact, over the past 10 years, despite the explosion in bank reserves, growth rates for M1 and M2 have been in the 2-4% and 4-6% ranges, respectively–approximately half the rates seen in earlier economic expansions.
The flow of funds data help explain this “conundrum”. Borrowing by the private sectors (households and business) has been unusually slow since 2009. Even with the big increase in borrowing by the Federal Government, total funds raised in the credit markets increased only 4.5% last year. That rate has been in the 3.5%-4.5% range since 2010. In contrast, it averaged almost 6% per year in the 1990’s and almost 8% per year during 2001-2007.
A collapse in mortgage borrowing is by far the main reason for the weakness in total borrowing. There were net declines in mortgage debt outstanding in the years 2010-2012, a first for this series. The volume of mortgage debt outstanding is till lower today that in 2009. Mortgage borrowing is now growing at a 2-3% annual rate, far less than the 7% average during the 1990’s and the 10%-15% annual rates seen in 2001-2006. Business borrowing also collapsed in 2009-2011, but it has recovered to a moderate pace in recent years. Mortgage borrowing has not posted such a recovery.
A very slow recovery in the housing sector has been a salient feature of this cyclical recovery. It helps explain why this has been s slow recovery in economic activity. It also helps to explain the anemic growth in mortgage borrowing. The housing sector is a huge user of borrowed money. And, if the demand is relatively weak, the price of borrowed money should be relatively low.
These data suggest that until the pace of housing construction and mortgage borrowing strengthens, interest rates in the U.S. are likely to remain unusually low. They could easily rise from current levels, but perhaps not substantially. One would expect housing activity to continue to gradually strengthen as memories of the financial crisis fade. But it may be quite some time until we see housing starts above the 2 million rate and the attendant strong growth in mortgage borrowing that we saw prior to the crisis.