Interest rates finally above inflation rates, which is normal outcome when Fed does not intervene in capital markets, US-based economist says
ISTANBUL
The US should begin lowering interest rates immediately because the country’s commercial real estate market is in a crisis due to high rates, a US-based economist said.
Citing recent developments in central banks’ moves around the world, Max Gillman, a professor of Economic History at the University of Missouri-St. Louis, said that the country has a different situation regarding the interest rate monetary policy and current inflation rates.
Gillman recalled that after the Sept. 11, 2001 terrorist attacks, the US led the trend of forcing down interest rates below the inflation rate, then the Fed quickly raised interest rates from 2004-2006 as inflation rose steadily up to 5% from close to zero.
The abrupt increase in interest rates after three years of negative “real interest rates” — the interest rate minus the inflation rate which is the real return on capital after inflation — led to investment banks going into insolvency because they held mortgage-backed securitized (MBS) loans that went into default, he said.
Gillman stressed: “The MBS were viewed as being a safer better investment than short-term US Treasury debt, which had negative real yields.
“But the sudden Fed increase caught homeowners off guard, since they had taken out variable rate home loans for 3 years at initially very low interest rates.”
The sudden increase in interest rates with variable rate mortgage loans caused homeowners to be unable to repay mortgages, leading to personal bankruptcy of many and the default of MBS held across the global financial system, he said.
So, the Fed caused the collapse of MBS and the 2008 banking crisis of investment banks going into demise because they raised interest rates too quickly, he added.
“After 2008, the Fed nonetheless again forced interest rates below the inflation rate for all but one year leading up to the 2021-2023 surge in the inflation rate in the US (and globally). This meant 20 of the last 24 years with interest rates below the inflation rate,” Gillman said.
“Then the Fed suddenly again raised interest rates in 2021-2024. Now for the last 8 months, the interest rate on 3-month Treasury debt has been 5.2% and inflation about 3.2%,” he reminded.
So, interest rates are finally again above inflation rates, which is the normal outcome when the Fed does not intervene in capital markets, he stressed, adding: “This gives a high real interest rate of a positive 2%, which is good, but quite sudden and now prolonged.”
-‘Interest rates must be decreased’
Gillman said: “Around the world, countries followed the US policy of driving interest rates below the inflation rate in order to have negative real interest rates on short-term government debt, like the US 3-month Treasury debt.
“They did this so that capital would not flow in and cause currency appreciation and more expensive exports, and therefore less exports.”
By keeping the same negative real rates as the US, countries kept their currencies from appreciating as they would have done if they had a positive real interest rate and so invited higher returns than elsewhere in the world, which would have caused the capital inflow, he added.
“Now the US policy of setting higher interest rates has again been followed around the world. In the US, I believe the interest rates must be decreased,” he underlined.
He also highlighted that countries, where interest rates are still less than the inflation rate, like Türkiye, should continue to rise until they are higher than or equal to the inflation rate.
-Major banks’ decision
The Fed, which began increasing its benchmark policy interest rate in March 2022, gradually raised it from 0.25% to a range between 5.25% and 5.5%, a 22-year high, and kept it constant during the last five monetary policy meetings.
Starting from July 2022, the European Central Bank (ECB) increased its fixed interest rate from 0% to 4.5% gradually until September and kept it unchanged during the last five meetings, including the last one on Thursday.
Beginning its rate-increase cycle earlier, the Bank of England raised its benchmark rate from 0.1% to 5.25% from Dec. 2021 to Aug. 2023, while it held the rate at the same level during the last five meetings.
Much earlier, New Zealand began to raise the rate in August 2021, from 0.25% to 5.5% till May 2023, and kept it constant during the last six meetings.
The Bank of Canada also raised its policy rate from 0.25% to 5% from March 2022 to July 2023 and kept it steady in the last six meetings.
From April 2022 to Nov. 2023, the Reserve Bank of Australia raised its cash rate from 0.1% to 4.35%; the rate in the country was unchanged during the last three meetings.
Despite major banks’ rate hikes, the Bank of Japan had been keeping the rate at minus 0.1% since 2015 but it decided to increase the rate to 0.1% in its March meeting.
Gillman said Japan’s decision is sensible because its inflation rate rose and the country wants to have a positive real return on government debt with interest rates above the inflation rate.
“This is all consistent policy with the US now pushing the real return positive on US 3-month Treasury debt, so that other countries want the same real return so as to avoid currency appreciation or depreciation with the US dollar,” he added.
The Swiss National Bank cut its main interest rate, making it the first major economy to start easing monetary policy, in March; the policy rate was cut 25 basis points to 1.50%.
Gillman said: “Countries in which the interest rates on short-term government debt are above the inflation rate are the ones in which we can expect to follow the Swiss bank decision.”
-Türkiye
Türkiye decreased the rate from 19% to 8.5% from mid-2022 to mid-2023 but then started increasing the rates.
The Central Bank of the Republic of Türkiye increased the rate from 8.5% to 50% from May 2023 to March 2024.
Gillman said it becomes easy to understand why Türkiye is raising interest rates if you understand that now they need to have a positive real return on short-term government debt rather than the negative return that the US promulgated for so many years.
Türkiye needs to lower the rate of growth of the money supply by having the central bank buy government debt at a slower pace, he said.
“This causes the interest rates to rise and the inflation rate to fall. Treasury needs to keep lowering the rate at which the central bank finances Turkish Treasury expenditure by printing money and causing inflation,” he said.
He underlined that in the end, it is this inflation tax that needs to be lowered dramatically, and the only way to do it is by printing money at a much lower rate, which means a lower rate of the central bank buying Treasury debt with freshly printed money.
“Interest rates then need to rise, and inflation would be forced downwards, until interest rates are above the inflation rate in Turkey,” Gillman said.
He said that this will also end the deterioration of Turkish currency value in international markets.