Why interest rates must rise
Economists hold up low interest rates as the answer to our problems, says Merryn Somerset Webb. They are, in fact, the cause.
Do super-low interest rates help the economy or hurt it? Economic models (the ones that central bankers use) tell us they help it. Low rates cut the costs of both servicing existing debt, and taking out new debt. This encourages some to spend, and some to borrow and spend.
The transmission mechanism is easy and obvious. Anyone who can't see how it works or who is calling for rates to rise when the global economy is still so 'abnormal' is therefore an obvious idiot. Or that is how the average economist sees it. We disagree. Why? Because the macro economic models we use today take no account of changing demographics and of behavioural incentives.
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The same goes for those with defined-contribution pensions: people who know they have to make a pot of cash last for 30 years find the low interest rates and huge market volatility our current monetary arrangements are giving them terrifying. Not comforting at all (I have an upcoming interview with demographic expert Paul Hodges that touches on all this look out for it).
Fans of low rates and QE will say that the low yield is an irrelevance the rise in the value of their assets (loose monetary policy has driven asset prices up) more than compensates. But rational as that might sound to economic model makers, it just isn't how people think. It is hard-wired into the UK financial brain, rightly or wrongly, that capital must not be spent only income can be spent. That's what matters to real people.
But low rates don't just have perverse behavioural effects on individuals. They affect firms too. Which CEO will sign off on a huge new investment programme when their pension trustees demand another couple of hundred million after every meeting, or, for that matter, when their industry is already riddled with excess supply? Super-low interest rates mean failing industries and no end of individual firms are effectively being constantly bailed out by the state. All the excess supply of the bubble period is still with us, whether it's useful or not, and it will be until rates eventually rise.
We have an interview with behavioural economist Richard Thaler in next week's issue in which I touch on all this in more detail. But the point is this: low rates may no longer be the solution to our problems, they may be causing our economic and hence political problems. They may be the thing making our environment 'abnormal'. There's more on how this affects politics in John Stepek's cover story. Clue: it's all about Jeremy Corbyn.
