Politics make the headlines, but it’s interest rates that change the economy. That is the conclusion that can be drawn from the last few days.
Even the less observant of us will know that a general election is coming up and that there seems to be a lot of political things going on in the United States as well.
However, what hit markets last week was the prospect that interest rates could fall a little more slowly than expected.
Spare us: we need more competition and less ideology from politicians, says Hamish McRae
It’s ridiculous, when you think about it, that it matters whether central banks should make two or three rate cuts this year, or whether they should start in June or September.
On the other hand, which politicians end up running the program does matter quite a bit. So what’s up?
The first part of the explanation is that politics generally affects the economy in the very long term, while the cost of money has an immediate impact on it.
You can see that in the UK.
The market reforms of successive Margaret Thatcher governments improved economic performance until the banking crisis of 2008-2009, but during the early years of that period the costs were as evident as the benefits.
The negative effect of Gordon Brown’s tax raid on pension funds and changes to pension regulation did not really become evident for a decade or more.
By contrast, when central banks failed to raise interest rates fast enough in early 2021, it was only a matter of months before the world experienced the worst burst of inflation in 40 years.
But it’s not simply a question of short term versus long term. It is also that politics is local, while the price of money is global.
So a different government in the UK can tinker with taxation and spending, and introduce different regulations.
But you cannot change the rate you have to pay to finance the National Debt, because it is set by global markets.
At best, it can have a modest influence in this regard, following policies that the markets approve (or the opposite, as Liz Truss tried to do). It can’t do much about mortgage rates or export demand.
UK growth appears to be recovering quite well this year, but that is partly due to a broader global recovery and partly due to falling inflation around the world.
The similarities between the different economic regions are much more marked than the differences.
You can see this better if you look at inflation. The UK’s peak of 11.1 percent was actually slightly above that of the United States at 9.1 percent and the eurozone at 10.6 percent.
But all were catastrophically above the 2 percent target, and our most recent figure of 2.3 percent is below that of the United States at 3.4 percent and Europe at 2.6 percent.
It is the difficulty in getting inflation back to target that makes central banks hesitant to cut rates. We are all in the same boat.
That said, there are reasons to think that the next three or four years will be modestly successful for the economy.
There is a global cycle from which we cannot escape. But, and this is important, we are in the middle of the growth phase of that cycle.
The pandemic upended everything, turning what was probably going to be a mild recession into a chaotic period.
Difficult decisions: It is the difficulty in getting inflation back to its target that makes central banks hesitant to cut rates
But since then there has been a decent recovery, although interrupted by rising inflation.
Last year there was a lull here and in some parts of Europe, but there are often setbacks like that. The U.S. economy has performed strongly, but growth has slowed recently and may fall further.
Each economic cycle is different. Remember that. But if we look at the details, there is a good chance that the global economy will continue to grow until the end of the 2020s.
The task of the next government is to take advantage of this period of growth to fix public finances, simplify regulation, encourage personal savings, improve its own services, etc.
More competition please and less ideology.
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