Investors are asking: Will 2024 really start to cut interest rates? While the geopolitical context could weigh on the smooth running of Western economies, Jean-Paul Pollin explains the difficulty for central banks to make a decision in the coming months.
In recent months, financial markets have seemed to be primarily concerned about the pace at which central banks will ease their policies, perhaps returning to the period of very low interest rates that preceded the return of inflation. We know that this “era of low interest rates” has given rise to various theories, the most striking of which has been to explain that it was the product of an excess of global savings due to capital flows from emerging countries in particular (especially China), but also of a collapse in productive investment in advanced countries (especially from 2008 onwards).
In any case, during this period, weak growth and inflation accompanied the weakness of interest rates. Not least because the abnormal level of these rates has led to inefficient investment choices and has kept unproductive companies alive. On the other hand, it has encouraged lax fiscal policies because of the low cost of public debt and because monetary policies have been disarmed because their key rates have come up against the constraint of their lower limit. In this sense, the end of this “era” of near-stagnation and instability should be seen as good news.
Excess savings are in danger of disappearing
Nevertheless, the interest rate anomaly has led to inflation in the prices of financial and real estate assets, which has been a boon for the markets concerned, from which it is understandable that their players hope to return. But it may well be that this return will not take place in the proportions and in the time frame that one imagines. First of all, because the dysfunctions in the era of low interest rates, which we have just mentioned, are serious enough for us to be careful not to fall back into this trap. Secondly, because the recomposition of globalization, as well as the necessities of the ecological transition, should encourage massive public and private investments at the global level and in particular in advanced countries; At the same time, international savings transfers are expected to dry up, for example if exporting countries decide to opt for domestic demand-led growth. As a result, the “too famous” excess savings may well disappear; at the very least, it will contract, leading to an increase in the long-term equilibrium real interest rate.
A choice between two equally dangerous directions
It remains to be seen how central banks are likely to respond to this new situation, since they retain control over a large part of the range of nominal interest rates. They thus have to choose between two orientations that are a priori just as dangerous. Because, if they follow the evolution of the equilibrium rate, i.e. maintain high rates or even increase them, they will aggravate the problem of sustainability of the public (but also private) debts of a good number of countries. An increase in interest rates at a time when growth forecasts are pessimistic, especially in Europe, would force fiscal policies to be very restrictive: the situation would be reversed from the prevailing situation (interest rates < growth rates) which allowed a deficit without an increase in the debt ratio. On the other hand, if central banks choose to ignore the increase in the equilibrium rate, i.e. revert to nominal rates that are too low, they will inevitably generate inflation, as recent experience has shown.
For the markets, as for the economy as a whole, the problem does not seem to have a satisfactory solution. But this is due to the fact that an equilibrium interest rate has been considered to be higher than the growth rate. Changing this assumption allows for a more optimistic picture of possible futures. Thus, the scenario of a revival of growth driven by a rebound in investment should make it possible to alleviate the constraint of past debt, while discarding the inflationary hypothesis and preserving the value of assets. But the realization of this conjecture is far from certain, and its uncertainty will probably continue to maintain market volatility for a long time to come.
