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May 17, 2010

Must interest rates rise?

There seems to be general agreement that interest rates will rise over the next year because the economy is recovering and the Federal Reserve's efforts are keeping a lid on inflation. But does everyone accept this forecast?

Dr. Mike Walden, North Carolina Cooperative Extension economist in the College of Agriculture and Life Sciences at N.C. State University, responds:

"Not really. ... The conventional wisdom is that interest rates will rise, and ... they will rise because loan demand will come back as the economy improves. And also because the Federal Reserve wants to head off higher inflation, they have kept their interest rates very, very low and so they will push their benchmark rates up.

"But although that is the majority opinion, there is a minority opinion that says, 'No, interest rates either will stay as they are or they may actually go down.' And this opinion is pinned on something called consumer de-leveraging. Translated: On what we've seen over the last couple of years, ... consumers have actually been paying down their debt. I know that is hard to believe, but they have been doing it. Because of the recession, because of the change, (the) situation in personal finances, consumer debt is actually going down.

"And the thought is that consumer debt is going to have to continue to go down. Because this recession has so devastated household finances, people are not going to be able to borrow like they used to. And they are actually going to have to pay down on debt.

"If that happens, then what we are going to see is consumer borrowing potentially go down, which could potentially negate any increase (in) the federal government or business borrowing. And that we would not have the demand there for new loans and that would put downward pressure on interest rates. Or at the worst hold interest rates where they are.

"So this is a very interesting battle between forecasters of where interest rates are going to go."

Posted by deeshore at May 17, 2010 08:14 AM