Figure 14-2: Increases in total domestic debt drive the prime rate
Over most of the 40-plus years since 1960, rising year-over-year increases in total domestic nonfinancial debt (black line) have led—typically with a one- to three-year lag—to higher interest rates, represented here by the prime rate (green line). Conversely, slowing growth in total domestic nonfinancial debt has usually resulted—with a similar lag—in lower interest rates. One notable anomaly in this relationship was the mid- to late 1980s.
If this relationship holds true in the future, the sharp increase in total domestic nonfinancial debt that resulted in part from the growing federal deficit of the mid-2000s seems almost certain to lead to higher interest rates in the current decade.
Current Comment: Year-over-year increases in total domestic nonfinancial debt (i.e., total demand for borrowed funds in the economy) in early 2006 passed the 10% mark after holding at 4%-7% from 1991 to 2000, but have modified a bit recently. The sharp increase in the Prime Rate from 2004 through early 2007 has faithfully reflected the earlier rise in debt growth but the two series now appear to be in equilibrium.
