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 helpful, 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 this chart—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, now at barely above “zero” %, can go in one direction only—higher.
