Why aren't the Fed's rate increases having a stronger effect on the economy?

A prominent economist, Henry Kaufman, says one of the reasons is the two-year mortgage refinancing boom that ended early last year.

"We have estimated that the cumulative effect of this refinancing was the equivalent of a $100 billion tax cut for the household sector, surely a source of ongoing stimulus for the economy," he said in a talk last week.

He added that families were not financially strapped "to any meaningful extent," and that ratios of debt to income have barely risen.

A second major influence, he said, is the improvement of liquidity by the nation's businesses.

With reduced credit costs and rising profits, companies could expand ambitiously "without requiring large amounts of external funding," he explained. "In fact, in this business cycle, the rate of growth of business expenditures for capital equipment has surpassed all previous post-war expansions.

"Increases in interest rates will only slow down the economy when economic participants are heavily dependent on outside sources of funds. Even now, that is not the case."

Mr. Kaufman, who heads Henry Kaufman & Co., New York, said it was fortunate problems in the mortgage securities market have arisen when liquidity in the system is strong. This has prevented the problems from spreading into other sectors, he said.

"The economy came into the new year with considerable forward momentum, but in doing so it was using up almost all the spare capacity of physical and human resources that existed at the onset of the economic expansion four years ago," he observed.

He warned that the pool of liquidity would soon be drained by economic activity and that vulnerability to events such as the Mexican crisis and the Barings failure would be much greater.

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