You can go your own way
Different countries are not only finding their own voice on trade, but also on interest rates, says Shamubeel Eaqub.
Interest rates and economies around the world are diverging. Central banks are addressing local economic circumstances, after nearly a decade of universally low interest rates. After an usual period of close synchronicity, economies are going their own way.
Interest rates are starting to rise in the United States. Unusually, the US official policy rate is higher than New Zealand, 2 per cent compared with our 1.75 per cent.
This happens very rarely, but illustrates changing economic conditions and outlooks.
Central banks set interest rates to manage the economic cycle. Like Goldilocks, the idea is to try to move interest rates in small increments so that economic growth and inflation are neither too hot, nor too cold.
It’s part science and mostly art. Central banks are changing interest rates now to influence the economic conditions in the future, often with a delay of a year or more.
The cost of getting it wrong is high. If interest rates are set too high, and anticipated strong economic growth and price increases do not materialise, then the central bank may have hurt an already soft economy.
Central bank policy mistakes are asymmetric. If a central bank raises interest rates too early in an economic cycle, it might damage the recovery, by reducing investment, jobs growth and income growth.
It is hard to kickstart a struggling economy, as we have seen over the past decade.
If a central bank doesn’t raise interest rates fast enough in a hot economy, then prices will increase too fast and the risk of a later slowdown increases. But it’s relatively easy to raise interest rates fast if the mistake becomes apparent.
This is the fine balancing act of central banks around the world.
In the US, the economy is strong and unemployment low. Inflation is still moderate. The US Federal Reserve has been gradually increasing interest rates, from very supportive levels towards neutral. That is, a level that doesn’t boost economic growth and does not dampen economic growth.
The US is expected to increase interest rates further, but it clearly sees the risk that the growth outlook is uncertain. The past decade’s economic performance has been unusually slow and expectations of accelerating growth and inflation have been premature.
Further, the US economic outlook is made more uncertain by an escalating trade war waged by the US. This could be a selfinflicted economic wound. The Fed is very aware of the economic risks and will take a gradual approach to raising interest rates.
The global economic picture is becoming more complicated.
In Europe, the economic recovery has been later and slower than in the US. Europe is looking to move from a very supportive central bank policy of quantitative easing, to unwinding that.
Interest rate increases are not yet on the cards. The economies are too slow and divergent to be subjected to higher interest rates. The level of interest rates will remain supportive of economic growth.
In Japan, they did nothing. The central bank continues to be super-supportive, as growth remains moderate and inflation is missing in action.
New Zealand is somewhere in the middle. Economic growth is good, but inflation is low. Current growth is good, but the outlook is less certain. Some indicators, such as confidence and house sales, suggest parts of the economy are slowing. Global trade wars could weigh on our economy.
Our central bank is unlikely to do much until it has high confidence that economic growth is assured and inflation is really accelerating.
The global economic picture is becoming more complicated. We are back to a more normal environment of diverging economic fortunes, after the synchronised recession of the global financial crisis, synchronised policy response from central banks around the work and the subsequent sluggish recovery.