Interest rates

It is an old adage that the market is a weighing machine in the long-term and a voting one in the short-term. The latest data published by the Federal Reserve in its Z1 Financial Accounts of the United States show the weighing and the voting pointing in sharply different directions. Read more


One of the most encouraging features of the US economy has been the recent improvement in the level of labour participation, which is the proportion of those aged 15 to 64 who wish to work (i.e. employed plus unemployed).

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Usually the Fed waits too long before raising interest rates. The pressure to delay is particularly strong today. One reason is the sharp decline in the trend growth rate of the US. As I have pointed out in these blogs, this is the result of a sharp fall in the growth of the population of working age and in productivity. In the decade prior to the financial crisis (1997 to 2007), the numbers in the US of those aged 15 to 64 grew at 1.38 per cent per annum and is now forecast to rise over the next decade at only 0.18 per cent per annum (chart one).

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Ian McCafferty, an external member of the Bank of England’s Monetary Policy Committee, believes “Britain’s ‘productivity puzzle’ will persist as the economy recovers because much of the decline in output is structurally entrenched.” As a result, Mr McCafferty believes that the Bank of England “should not ‘hold back too long’ on interest rate rises”.

Scarcely a day passes without some reference to the UK’s “productivity puzzle” and a claim that the poor productivity is “inexplicable”. This reflects a failure to understand how and why the economy has changed. Poor productivity is so readily explicable that it should cause no surprise. It is, as I have sought to explain before, the natural result of the change in management incentives. Read more

It is widely, but by no means universally, accepted among economists that the “rate of interest” is closely related to growth. It is, however, also generally accepted that this applies to a closed economy, such as the world as a whole.

The growth rate of G5 countries has been declining steadily for years, and this trend has recently accelerated, as chart one shows. It seems likely that low growth has become endemic and this is being widely interpreted as implying that real interest rates will remain low. This view strikes me as being unjustified on theoretical grounds and is also a very dubious conclusion to draw from the past. Read more

“When will the Bank of England raise interest rates?” is the usual question. “When should it?” is the important one. The bank has a long history of “acting too little and too late”. As I explained in inflation and deflation, inflation is more dangerous than deflation and prudent central bankers would rather act too soon to raise rates than be too late and then be forced to cause a recession to get inflationary expectations back under control.

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