EDITOR'S LETTERMerryn Somerset Webb
Why interest rates must rise
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.
Western populations are ageing. Older populations react to low rates in ways that models just don’t recognise. Those with final-salary pensions read about the huge pension deficits at their former employers, caused by low interest rates (it’s technical, but the lower rates go, the higher deficits go). This doesn’t make them want to spend. It makes them worry that they will soon have nothing to spend.
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.
• Read the full editor’s letter here: Why interest rates must rise