Across the globe, central banks are getting nervous. Nowhere is this presumption more present than rate changes over the past month.
Here’s a list of central bank rate changes over the past month.
- Denmark reduced their rate to -0.05%;
- Chile reduced their rate to 3.25%;
- Peru reduced their rate to 3.5%;
- People’s Banks of China reduced its repo rate;
- Romania cut its policy rate to 3.0%;
- Poland reduced its rate by 50 basis points; and
- Korea dropped its rate to 2%.
Theoretically, the rate reductions are a result of central bankers becoming concerned about the health of certain economies.
Let’s put the rate changes in context.
Central banks’ policy rate changes
Here is what central banks have done with their main policy rate recently (right axis) and over the past 25 years.
Unsurprisingly, the rise of the importance of central banks has been associated with lower overall rates (i.e. a downward trend line is present across the globe).
The presence of the downward trend poses the question: Is it good that central banks are generally becoming more loose with their rates?
Here are four reasons continued central bank meddling, in the form of unattractive short-term interest rates, are counterproductive.
First, central bank easing evaporates interest income in search of a completely theoretical idea that lower interest rates will boost economic activity.
Here’s what the missing interest income is around the globe.
The left figure is the estimated missing interest income by country by year.
The right graphic is the methodology. The methodology basically comprised estimating the trend in interest income and where it has been since central banks started meddling with interest rats.
On the whole, missing interest income is about $7 trillion globally since 2009.
Why does the missing interest income matter?
Simply put – the missing interest income matters in that it causes shifting among economic agents. In particular, one major shift is the increasing length in which the older generation is staying in the workforce.
As a byproduct of the older generation‘s decision to continue to work, the younger generation has seen limited prospects with the labor market.
Why is the older generation continuing to work?
An important component is that the value of their investments, interest income being a major component, has performed poorly.
Central banks: Low interest rates has boosted inflation
Second, incredibly low interest rates send an inaccurate signal. Overall, central banks are saying – “we think the global economy is weak.”
The exact message central bankers shouldn’t be sending is what they’re sending.
Third, there’s little to no evidence that the global experiment with such low interest rates has boosted inflation.
On the contrary, instead of high inflation, central bank policy has been correlated with low inflation.
This fact is partly a result of the way central banks work. As reactos, central banks respond to inflation, rather than being ahead of the curve. It’s the nature of a political institution.
With no evidence that their incredibly low interest rates are boosting inflation, it’s quite interesting that central bankers continue to spout off such beliefs. Mr. Draghi and others should learn that textbook economics is sometimes best left in the textbook.
Fourth, there’s no evidence that central bankers’ low interest rates are boosting economic growth in any material way. By and large, central bankers are acting on ideas written in textbooks that are really irrelevant. Central bankers should look at the evidence, not theory.
Overall, central banks continue to think their low interest rate policies will help the global economies, regardless of whether there’s any evidence to support their views.