Is this it?
The markets have been trembling for what seems like years over interest rates. Central banks, of course, see them as a tool to control inflation. But homeowners and other borrowers are feeling the pinch. So much so that many Canadian premiers have gone directly to the Bank of Canada, cap in hand, begging for an end to what they see as punitive hikes.
On September 6, The Bank of Canada responded, holding its target at five per cent.
“Inflation in advanced economies has continued to come down, but with measures of core inflation still elevated, major central banks remain focused on restoring price stability,” the Bank of Canada said in a press release. “Global growth slowed in the second quarter of 2023, largely reflecting a significant deceleration in China. With ongoing weakness in the property sector undermining confidence, growth prospects in China have diminished. In the United States, growth was stronger than expected, led by robust consumer spending. In Europe, strength in the service sector supported growth, offsetting an ongoing contraction in manufacturing. Global bond yields have risen, reflecting higher real interest rates, and international oil prices are higher than was assumed in the July Monetary Policy Report (MPR).”
The real question is one we might not have the answer to without the benefit of hindsight. That is: “Is continued interest rate hikes the right thing to do right now?”. In December, Bank of Canada Governor Tiff Macklem said it was a line he was willing to cross, asserting that he would rather make the mistake of raising interest rates too much rather than not enough.
“If we raise rates too much, we could drive the economy into an unnecessarily painful recession and undershoot the inflation target,” Macklem said. “If we don’t raise them enough, inflation will remain elevated, and households and business will come to expect persistently high inflation.”
South of the border, notable and recent opposition has come in the form of Nobel Prize-winning economist Joseph Stiglitz.
“The Fed thought the source of the inflation that began in the post-pandemic era was excess demand, and you could understand why they may have thought that if they didn’t do their homework,” Stiglitz told CNBC recently. “It’s really bad economics, because [the Fed] saw that the government had passed this enormous recovery program, and if all that money had been spent, it would have been inflationary, but you have to remember back just a few years ago, there was an enormous amount of uncertainty.”
Yet another Nobel Prize-winning economist agrees. Christopher Pissarides agrees with Stiglitz.
“It takes time for these to have their full effect, so given that inflation is moving in the right direction, that interest rates are high, I would just wait and see what happens next,” he said recently. “I don’t expect anything to happen to make them want to increase interest rates more, but I would definitely wait this time.”
But others think The Fed is not making a mistake at all.
“The Fed is doing the correct thing,” said Raymond James Chief Economist Eugenio Aleman recently. “Interest rates on savings are going up, so that will put pressure on consumers between consuming and saving, which is something that we haven’t had for the last 20 years or so.”
One issue is that central banks are tackling a problem that, while not thought to be extinct, was certainty on the endangered list.
“We have had price stability for a very long time and maybe come to take it for granted,” Jerome Powell, chairman of the Federal Reserve candidly said in April.
Meanwhile, Tiff Macklem seems to worry about the persistence of the unfamiliar foe.
“With recent evidence that excess demand in the economy is easing, and given the lagged effects of monetary policy, Governing Council decided to hold the policy interest rate at 5% and continue to normalize the Bank’s balance sheet,” Yesterday’s Bank of Canada release concluded. “However, Governing Council remains concerned about the persistence of underlying inflationary pressures, and is prepared to increase the policy interest rate further if needed.”