Controlling the Economy with Interest Rates Does It Accomplish the Task on the Consumer Side?

Interest rates have and will always be used by the Federal Government as an instrument to tighten or expand the U.S. economy. Interest rates, adjusted for inflation, rise and fall to balance the amount saved with the amount borrowed, which affects the allocation of scarce resources between present and future uses1. The Federal Government uses both fiscal and monetary policies to adjust the spending levels within the economy. Fiscal policy refers to the government increasing and/or decreasing taxes or spending to control economic growth while monetary policy is the use of interest rate fluctuations to achieve this same goal. Interest rates influence the borrowing and saving of business investors, consumers, and government agencies1. If the economy is expanding too fast or tumbling out of control, the government steps in and attempts to correct the imbalance. A weakened economy is usually sparked by a drop in interest rates while an increase in rates usually signals inflationary rise. High inflation is the result of money supply increasing at a rate greater than the expansion of the economy. Governments may opt to use one or a combination of both policies to attain the desired result.

The common theory involving interest rates is that as interest rates rise consumers and producers will save more and purchase less and as interest rates fall they will save less and purchase more. Ultimately, the government is increasing/decreasing incentives for persons to save or spend. This theory works well for the corporate arena but is not necessarily true for the consumer side of the equation. Today, people have the ability to spend more and more because of the increasing credit handed to consumers. Our Nation, from the individual to the Federal government has adopted a buy now and pay later philosophy. Not only do we now charge everything imaginable but today the average person only manages to save roughly 3% of their total income. The personal savings rate has decreased by 40% since 1985 while outstanding

credit balances have increased by 60%. These peculiar habits provoked the following study in an attempt to determine, if indeed, fluctuation of U.S. interest rates affect the average consumer's spending habits.

Figure A2

Durable goods are considered goods purchased with the intent to last over time. Examples of durable goods are appliances, autos, household electronics, computers, home furnishings, and any good purchased that has an expected life of at least three years. Using durable good sales as the dependent variable and prime interest rates, personal income, consumer credit outstanding and personal savings rates as independent variables, data was collected quarterly from 1985 until 2004. All dollar figures were adjusted for inflation using 1980 as the base year. Total dollar amounts were then divided by the total employed during that given time period. The compiled data was then entered into Microsoft Excel and a regression analysis was calculated. The initial results revealed outstanding credit possessing an extremely low P-value

and a t-stat value exceeding the tabular value. This information may result in outstanding credit being a non-significant value. This interpretation makes perfect sense assuming the majority of durable goods are purchased on credit. As durable goods purchases increase, credit is likely to increase at the same rate. After removing the outstanding credit variable a new regression analysis was preformed. The corrected Excel analysis is shown in Figure B below.

Figure B

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.840186696

R Square 0.705913685

Adjusted R Square 0.694305014

Standard Error 160.6343953

Observations 80

ANOVA

df SS MS F Significance F

Regression 3 4707252.159 1569084.053 60.80917661 3.76111E-20

Residual 76 1961059.081 25803.40896

Total 79 6668311.24

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%

Intercept 470.0290325 734.9166599 0.639567802 0.524376846 -993.6843264 1933.74239