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business newsCould Higher Rates Kill Growth?
By
James Kostohryz
Feb 01, 2010 10:30 am
Five considerations to keep the conversation in the proper context.
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Several news items spooked investors worried about the potential impact of rising rates, including rumblings out of China regarding the need to reign in credit growth, a surprising 75bp interest rate increase by the Indian Central Bank, and a dissenting vote within the FOMC in the US by a member objecting to the explicit commitment to maintain rates at “exceptionally low levels… for an extended period.”
Placing Discussions of Interest-Rate Cycles in a Proper Context
There can be little doubt that interest rates around the world have bottomed, and that they can only rise from current levels. However, as one contemplates this state of affairs, for proper context, I'd advise keeping in mind the following:
1. History has shown that higher interest rates should be celebrated as byproducts of economic recovery, not as harbingers of recession. The majority of empirical economic work on the subject demonstrates that economic activity is far more important than rates when it comes to stimulating credit demand. Thus, rising interest rates generally signify a rise in credit demand relative to supply and therefore are lagging indicators of increasing economic activity.
2. Growth trumps rates. Empirical evidence shows that, in terms of stimulating economic growth, the increases in wealth and income that are associated with increased economic activity are far more important than increases in the cost of credit. This means that in the context of an economic recovery (particularly in the early stages), growth can be, and usually is, sustained despite rising rates.
3. Rates have a long way to go before they will provide a challenge to growth. Policy rates are currently at exceptionally low levels. For example, in the US, it would take a large number of relatively large policy-rate increases for interest-rate policy to go from “exceptionally low” to be merely considered “accommodative”.4. Monetary policy, particularly in developed economies, will likely remain accommodative for a prolonged period. This is particularly true if the pace of recovery is muted (as widely predicted) and/or if unemployment remains high for an extended period (also widely anticipated).
5. Watch emerging markets. In the past, developing country markets have been extremely sensitive to developed markets’ interest-rate cycles. This is due to the former’s historical dependency on the latter for capital inflows. However, this traditional situation no longer applies in many cases (the reverse is often true) and, on the whole, developing countries are today much less dependent on the wealthy nations for capital. Furthermore, a scenario of low-to-moderate growth in wealthy countries (as widely predicted) will not only imply accommodative monetary policy and plentiful global monetary supply, it will also imply unusually easy capital availability for developing nations as sluggish credit demand in wealthier nations will imply that a greater share of global liquidity will be available to go to the developing world. The scenario of accommodative global monetary policy together will slow to modest growth in the developing countries represents a “sweet spot” for emerging markets. It insures ample liquidity to finance economic growth in these developing nations.
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