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Originally posted by Mmmm, Burger (C.J.)
I think this simplifies things somewhat and looks slightly to the wrong place. Bond traders look to what the likely rate of inflation will be, which is influenced by a host of factors, including both monetary and fiscal policy. In the 70s, monetary policy was inflationary. Reversal in the early 80s caused a predictable recession. Until Greenspan came in, monetary policy had generally been loose for quite some time. And until he made clear that a tight monetary policy (or a reasonable one--expanding money supply in close relationship to growth) was here to stay, we had higher bond rates because people were worried about more inflation.
Fiscal policy plays only a secondary role, especially on the long bonds (such as mortgages, which generally are treated about like 10 year bonds). The main concern is that if we run continuing deficits we will have inflation, either because there's too much money chasing too few goods or because eventually we'll have to inflate our way out of the deficit. Greenspan has, through long-term work, convinced bond investors that the latter will not happen. Until the deficit (and, more important) the debt becomes too large to make continuing that approach infeasible, people believe it, or at least think the risk of a diferent approach is quite low.
So, don't tie it to Congress any more, other than to thank them for confirming repeatedly Reagan's pick for Chairman of the Fed.
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The way I understand it, with the long term rates the budget deficit is a big factor. If you have high deficits then everyone assumes there will be inflationary pressure. So for the long term the deficit is a big deal. Greenspan can fight inflation but if the deficits remain high, he has to raise interest rates to combat inflation. The higher the deficit the higher he has to raise interest rates, and the short term rates push up the long term rates. Or, ino ther words, if your bank has sold your long term rates to low and then the short terms rates go up later you take a bath.
When I was in the bond trading circles from 92-96 everyone talked about the deficit. Every stupid lunch or dinner I went to everyone was talking about Rubin, Ways and Mean, or after 94 Gingrish and how much discipline he will impose. Because they were clients I had to suck it up and listen to it instead of screaming at these guys to get a life and talk about something else. But man they were obsessed with the federal deficit.
But maybe now that has changed and that is why long term rates are low even though the deficit is high.
