Chris Johns: What seems normal in interest rates is very strange

Ireland’s rate of growth is extraordinarily high by global economy standards

US Federal Reserve chairwoman Janet Yellen:  peppers her speeches with references to ‘equilibrium interest rates’. Photograph: Kevin Lamarque/Reuters

US Federal Reserve chairwoman Janet Yellen: peppers her speeches with references to ‘equilibrium interest rates’. Photograph: Kevin Lamarque/Reuters

 

Should interest rates be now be raised in order to boost inflation? One of the worthies who sits on the Bank of England’s monetary policy committee is likely to retire soon without ever being party to a rise in interest rates.

It is eight years since UK rates were last hiked. In the US it is nine years since the Federal Reserve last tightened policy. UK interest rates are at 300-year lows. There are many investors, borrowers of all kinds – including mortgage holders – around the world who have never lived through an officially sanctioned rise in the cost of debt. This is likely to change in the coming months. In the US and UK it is a fair bet that interest rates will be increased some time in 2015. Anyone who has become used to ultra low interest rates will need to take notice.

That said, hardly anyone thinks that rates are likely to either rise quickly or by much. Closer to home, any rise in ECB rates looks still to be years away. Further afield, China is easing and the Japanese are well into their next decade of ultra low rates. We all believe that we are in a prolonged era of minuscule borrowing costs.

Even Irish variable rate mortgage holders are, historically at least, not being asked to pay high rates.

All of which is curious. What seems normal is, in fact, very strange. Just why interest rates are so low is taken to be a function of the lingering effects of the great financial crisis and the subsequent relatively sluggish global economic recovery.

Ireland’s current rate of growth is extraordinarily high by global economy standards.

Inevitably, there is a debate going on about the meaning behind all of this. At times, that discussion can seem abstruse. Janet Yellen, the head of the US Federal Reserve, peppers her speeches with references to “equilibrium interest rates”.

Economists such as ex-US treasury secretary Larry Summers thinks that a variety of factors have come together that mean the correct, or equilibrium, interest rate is now negative.

This has also been dubbed the “secular stagnation” hypothesis because the drivers of warranted negative rates are things like lack of investment opportunities, poor demographics and a host of other factors that mean we all want to save rather than spend.

The only thing that can force us to become spenders is a negative interest rate, something that central bankers are, more or less, powerless to deliver.

Weirdness

Economics in general is an arcane subject and monetary economics is doubly so, sometimes to the point of weirdness. Some academics think the situation is now so peculiar that the only thing that can generate inflation is a rise in interest rates (really).

Whether or not this counter-intuitive argument holds water, it is certainly the case that should economies slow down or go into recession, central bankers have very little ammunition left to boost flagging growth. Everybody is worried about this.

When official interest rates first approached zero and trillions of dollars and pounds printed by central bankers, opponents argued that hyper inflation would result. Central bankers – and most economists – retorted that low rates were necessary to boost growth and get inflation back to target. Both camps were dead wrong.

No consequences

Money printing on a vast scale along with zero interest rates had virtually no consequences; or, at least, ones that were tiny and utterly unexpected by just about everyone.

One or two economists have suggested that the best thing to do is to get rates back to some kind of normal level. They use surprisingly simple models – that orthodox economists like to trash – to show that this will raise inflation.

They go further: prolonged zero rates are the prime cause of deflation. Whether or not this is simply heresy, there is a growing feeling that years of zero interest rates may be causing problems in ways that we do not fully understand.

The great monetary experiment has revealed a huge gaping analytical hole that economists don’t know how to fill.

One, very scary, conclusion is that central bankers don’t really know what they are doing.

That’s not their fault, more a reflection of the very, very strange monetary times that we are living in.

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