How floor rates do more harm than good


The sentence was uttered with the kind of menacing grinning debaters who reserved for a knockout rhetorical blow.

During their heated exchanges over the management of the economy in their televised debate on Monday, July 25, former Chancellor Rishi Sunak looked to his opponent to become Prime Minister, Liz Truss, and demanded to know if she knew about mortgage rates in the United States. States.

“Come on, what are they,” he gasped as Truss remained stone-faced. If she admitted that rates have nearly doubled in the past six months, which they have, he would clearly think that this would prove fatal to her economic plans. The economy cannot possibly be entrusted to someone who is reckless.

But wait a minute. Is that really true? We have been living in a world of almost zero interest rates for 14 years now. We have become so used to it that we hardly talk about it anymore. And yet it now looks like they are finally coming to an end as central banks around the world begin to grapple with rising inflation.

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In the US, the Federal Reserve raised interest rates this week by 0.75 percentage point, the fourth consecutive increase, and the benchmark lending rate is now at 2.5 pc.

The Bank of England is steadily raising interest rates and will no doubt do so again in August. Even the European Central Bank (ECB) has finally, albeit belatedly, joined the party, rising 0.5 percentage points, the first rise in ten years with interest rates essentially negative. Perhaps, as Sunak clearly believes, that will be a catastrophe for the global economy, bankrupting households and businesses, and we should do everything possible to keep cheap money flowing forever.

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And yet it’s also possible that zero rates were always an illusion, and one that ended up doing more harm than good. Ultra cheap money created a bitter generation gap as rising house prices made it impossible for younger people to get up the real estate ladder; it created legions of zombie companies that were barely kept alive on easy credit; it encouraged ill-considered spending by governments who thought the bills would never be paid; it caused a debt explosion and asset price bubbles; and it destroyed the incentive to save.

It’s true that free money could have helped save the economy in the wake of the 2008 and 2009 financial crisis. But one day, interest rates will have to return to normal — and now’s the time.

“By any historical measure, interest rates have been exceptionally low over the past 14 years,” said Nicholas Crafts, a professor emeritus at Warwick University and an expert in British economic history. “Even in the [worldwide depression of the] In the 1930s they did not go below 2 pc, and even that was only for a few years. And yet growth, productivity and investment during that time have also been very weak.”

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The zero-rate era has lasted much longer than anyone originally thought possible. Rewind to 2008, with banks around the world crashing, and with the financial system in turmoil, and central banks around the world cut interest rates to 300-year lows. From 5 pc. Before the crisis, in March 2009 the Bank of England had cut interest rates all the way to just 0.5 pc, the lowest level since its creation in 1694, in an attempt to stimulate the economy.