Is it because interest rates are expected (guaranteed?) to lie within a narrow enough bound that the base does not make much difference? Unlikely. Both inflation and real rates are volatile enough, even over shorter periods of time, to give lie to that. Or perhaps the reasons are purely (or mostly) historical.
Or is it because spreads thus expressed are an indicator of bank profitability? If the bank is operating at a fixed spread, then it matters little what the cost of lending and borrowing are. The differential is the return on the asset base (which logically being a fixed multiple of equity) and thus the return on equity.
This explanation is slightly more credible, but fails to take into account changes to the business models of banks over the last decade as well as the involvement of players other than "banks" in the financial system. Not everyone is contrained to leverage on equity. In fact, I'd suspect that the number of players that gear up on cash flows far exceeds the former.
So if we're not to express spreads (or changes to base rates) as absolute differentials, then how else? Clearly, a purely relative change a la stocks holds less meaning than for the latter. Consider this: "The Fed today decreased its benchmark funds borrowing rate by 28.5%. The market expects further easing of between 33% adn 66% in the coming quarter", instead of: "The Fed today slashed its benchmark funds rate from 1% to 1.5%. The market expects futher easing of between 0.5 % or 1% over the next quarter".
I recently came across a passage in an article by Percy S Mistry in The Financial Express that brought out the absurdity of doing this (emphasis mine):
First, the Fed reduced rates to unprecedented levels. Then, it jacked them up
mechanically to five times the low rate over 21 months. It would be like RBI
raising rates to 30% in the next two years and not expecting trouble to arise!
Clearly Mr. Mistry is equating the tightening from 0.5% to 2.5% to RBI tighening from 6% to 30%. To me, the case under question is a lot closer to a scenario where RBI tightens from 6% to 8%. Not quite the disastrous policy that Mr. Mistry accuses the Fed of. But he does have a point: I'd expect borrowers to have been more adversely impacted by the Fed's action compared to RBI's analogous equivalent action by my definition.
Here's my proposal: express interest rates as (1 + r). This number needs a name. While I'm sure someone has already named it as well as made a similar proposal, it's hard for me to find this out (google search his not amenable to this sort of thing), besides it is an original proposal for me anyhow. So, I propose to call it "pips". A 5% interest rate is 1.05 pips, 0.5% would be 1.005 pips. Now, we can meaningfully express pips differentials as percentages. If the Fed tightens from 0.5% to 2.5%, that's a 1.9999% tightening in pips terms from 1.005 to 1.025. The equivalent RBI action would be to tighten from 5% to 7.1%, i.e. from 1.05 to 1.071 pips.
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