The reason why interest rates may not be able to stay low for much longer

There was one big reason why it was realistic to cut interest rates down to around zero in 2008 and keep them there, that reason may not apply for much longer.

Article updated: 27 August 2019 12:00pm Author: Michael Baxter

Nouriel Roubini, the economics professor from New York University who predicted the 2008 crash more accurately than anyone else in the world, says that there are three reasons why the global economy could be heading for recession. Those reasons are:

  • Chinese US currency and trade war
  • Slowly brewing Chinese and US technology war
  • Oil supplies and danger of a war in Iran leading to a spike in oil prices

But, he says there is one big problem this time around. Previously, central banks around the world cut interest rates to record lows in order to try and stimulate demand. This time, the underlying cause of a global recession would not be a demand deficit, rather it would be down to supply shocks.

“Such shocks cannot be reversed through monetary or fiscal policymaking,” Roubini said, “Although they can be managed in the short term, attempts to accommodate them permanently would eventually lead to both inflation and inflation expectations rising well above central banks’ targets.”

Meanwhile, President Trump slates Jerome Powell, chair of the US Federal Reserve.

Powell warned over the economic risks of a trade war and Trump tweeted back: “..My only question is, who is our bigger enemy, Jerome Powell or Chairman Xi?”

As the world repeats the errors of the 1930s, draws in on itself, the US acts like a bully, helpless Britain, post Brexit, will have no choice but to act as the bully’s henchman, less it gets turned upon.

Globalisation was the most important driver of the global economy these past two decades. Globalisation led to surging global output, but thanks to German and Chinese savings rates, thanks to the surge in corporate profits relative to wages, and thanks to rising inequality, demand struggled to keep pace with rising output potential.

As a result, we saw ultra low inflation/deflation, and the surplus of cash looked for safe havens — it found bonds, and pushed down on their yields.

The problem of lack of demand was partially fixed by debt. Before 2008, demand was propped up by consumer debt. That came terribly unstuck in 2008, but this decade consumer debt, government and corporate debt have been increasing to terrifying levels. But at least interest rates have been low.

But if globalisation goes into reverse, and nationalism around the world is likely to have this effect, global output will fall.

The problem changes from finding ways to create sufficient demand to meet potential output, to one in which potential output falls.

The reason why it was possible to cut interest rates to zero — or near zero — goes away.

That is why anti globalisation was always so dangerous. That is why the politics of Trump pose a massive threat to global stability.

As for investors — well, higher interest rates are bad for stock markets as it means the rate at which future profits are discounted, to give a net current value, increases.

No, the best thing investors can do is understand the new reality. Unless technology innovation can compensate for the reversal of globalisation, or unless a new generation of leaders emerge who promote globalisation and global cooperation again, there is trouble ahead.

These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Michael Baxter portrait photo
Michael Baxter

Economics Commentator

Michael is an economics, investment and technology writer, known for his entertaining style. He has previously been a full-time investor, founder of a technology company which was floated on the NASDAQ, and a director of a PR company specialising in IT.

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