Figure 12-2: The discount or fed funds rate as a leading indicator of real consumer spending (PCE)
Over time, year-over-year changes in the Fed-managed discount or fed funds rates (green line, inverted on chart, right scale) have been a generally reliable, though not infallible, leading indicator of consumer spending. Rising Fed Funds rates set by the Fed, which make borrowing more costly, have typically led to slowing growth in consumer spending (black line). Conversely, falling discount or fed funds rates, which make borrowing less expensive, have almost always presaged upturns in consumer spending. An exception to this relationship was in 1984-1986, when the (at that time) Discount Rate was lowered and consumer-spending growth continued to slide and, again, in 2007-2008, when even a dramatic lowering of the Federal Funds Rate failed to stem the 2008 decline in consumer spending.
Current Comment: The sharp reduction in the Fed Funds Rate in 2007 and 2008 did little to arrest the sharp slowdown in consumer-spending that ensued in 2008 and early 2009, as the combined crises in housing and financial sectors overwhelmed all other influences. The value of Y/Y changes in interest rates (tracked in the green line) as a leading indicator is much reduced at this time, since the Fed Funds Rate, at 0.25% in early 2010 cannot go appreciably lower. Indeed, with real-consumer-spending growth having improved markedly since early 2009, and given a return to moderate consumer price inflation in late 2009 and early 2010 versus deflation in much of 2009 (see following figure), it is likely that the Fed Funds Rate will be increased at least moderately at some time during the coming year.
