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To: Phaedrus; B.Bumbleberry; sourcery
I've been following the thread with some interest, and while I would not presume to speak for sourcery in any way, I do not understand Phaedrus' last response.

Phaedrus: post #78: I see real interest rates gravitating around and tending toward a few percentage points above zero over time, the "real rate of return". The graph thus supports my argument.

Phaedrus' arguments were:

Phaedrus post #49:
Interest rates track exceedingly well to actual inflation alone. Expectations have a minor, short-term effect, offset by reality in the medium term (months).

Phaedrus post #63:
Interest rates track to inflation nearly perfectly and exchange rates track to relative inflation nearly perfectly, statements to the contrary notwithstanding.

Phaedrus post #66:
Interest rates are generally considered to have 2 components: the "risk-free" rate, the proxy for which is typically the 1-year T-Bill, and an "inflation premium". Add the 2 and you've got today's rate.

Phaedrus post #67:
Our discussion revolves around interest rates to those who pay their debts timely, however.

The lower graph in Sourcery's post #72, is the Real Interest rate adjusted for the inflation rate - i.e. real interest rate excludes inflation, thus removing the 1st of your 2 components.

As you agree the conversation centers around individuals who pay their debts timely and the graph covers T-Bonds & T-Bills, there should be no variation in the risk premium, thus removing the 2nd of your 2 components.

Yet after removing both components, clearly, the real interest rate graph shows a variation of:

1.5% - 4.5% for the long bond, and;
-2% to 1.5% for the T-Bill
over the last 2 years - 24 "months", the "medium term" you asserted over which "expectations have a minor short-term effect".

Variations of 3 to 3.5%. After effects of inflation and risk have been factored out.

I presume a 20-year corporate banker would not consider 3-3.5% real, risk-free interest over two years to be an insignificant. No? After negotiating terms, would you be willing to reduce the rate to creditworthy borrowers further by those points? I suspect not. I suspect you view 3-3.5% real risk free interest very significant.

So I fail to see how the graph supports your assertions that:

Interest rates track exceedingly well [or nearly perfectly] to actual inflation alone.

The 2 components, the "risk-free" rate and an "inflation premium" sum to the current rate.


90 posted on 10/20/2003 4:00:56 PM PDT by Starwind (The Gospel of Jesus Christ is the only true good news)
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To: Starwind
I presume a 20-year corporate banker would not consider 3-3.5% real, risk-free interest over two years to be an insignificant.

Interest rates, the price people are willing to pay for money, reflect every human motivation imaginable. That the real rate of return varies 2% - 3% around a mean over time is not at all out of line. Do you take issue with the market rate being a reflection of the sum of the real interest rate (generating a real return) and an inflation premium as a general rule and over time? This is the fundamental point and consistent with my earlier posts. If you do, please elucidate.

Let me add from personal experience. I watch mortgage rates move with the 10-year Treasury bond daily. The spread between the 2 varies all the time as a function of what bond traders think the Fed will do, retail sales, employment and on and on. If you're looking for perfect correlation, you will never find it.

91 posted on 10/20/2003 5:25:36 PM PDT by Phaedrus
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To: Starwind
I presume a 20-year corporate banker ...

It's actually closer to 40 but you notice I don't lean on this much in my posts. The point is that those who only do theory come and go and their forecasting track record is generally abysmal. Another point is that in my experience many claimed they were able to forecast exchange rates (I managed corporate currency risk for 22 years). Most failed, and those who employed econometric models failed the worst, but there were a few individuals who could develop an accurate "feel" for where markets were going and could indeed accurately forecast, not always but way better than the averages. FWIW ...

93 posted on 10/20/2003 5:39:26 PM PDT by Phaedrus
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