Interest Rates: Between Curbing Inflation and Stimulating It

-        Although the most recent U.S. interest-rate increase, which amounted to 0.75% on 15-6-2022, and further increases as expected, were intended by the U.S. Federal Reserve Board to contain high inflation and reduce elevated prices in U.S. markets, other countries such as China are extremely worried about the dangers of these measures by the U.S. Federal Reserve Board. The Chinese fear the flight or migration of Chinese capital owners to the U.S. financial market to invest in U.S. Treasury bonds, whose yields will rise as borrowing interest rates increase. Meanwhile, in Chinese markets there are restrictions on lending and credit facilities, an appreciation of the yuan, and the closure of some major Chinese cities due to a partial resurgence of the COVID-19 pandemic.

-        China had urged the West not to rush into raising interest rates and warned of "serious consequences." Although its holdings of U.S. debt, estimated at $1.2 trillion — second only to Japan’s $1.8 trillion — are largely invested in U.S. bonds, it appears that part of these bonds mature at long terms (30 years) with low yields.

-        Although China is worried about U.S. rate hikes, some developing countries will benefit from them in several key ways. For example, pushing U.S. interest rates higher will open a strong market for these developing countries’ exports. If the dollar and the euro appreciate, it means U.S. and Eurozone exports become more expensive, and importers will look for alternative (cheaper) markets. Also, exporters’ receipts in dollars and euros in emerging economies will be larger when converted into local currency.

-        Despite that, tightening policy at the Federal Reserve and other major central banks can make the situation for developing countries worse — there is a risk of capital flight, currency weakening, and making debt servicing more difficult. The International Monetary Fund and the World Bank have already warned of this scenario. Chinese President Xi Jinping also did so in an "unconventional" speech at the World Economic Forum in Davos.

-        He said: "If major economies slam on the brakes, or take a turn in their monetary policies, there will be challenges to global economic and financial stability, and developing countries will bear the greatest burden of it."

-        Although China, according to some economists’ expectations, has a probability of high inflation that is 50% lower than that of the United States — 58% — they also expect inflation levels in China to fall, with their forecast at 25%. Meanwhile, economists did not expect U.S. inflation to decline in 2022 (IMF studies and The New York Times bulletin dated 16-6-2022).

-        Regarding negative interest-rate policies: some central banks of major countries and economic blocs resorted in recent years to so-called "negative interest rates," while others view raising interest rates as the primary tool to rein in inflation and rising prices. Other countries have moved interest rates into negative territory. Japan, for example: in January/December 2016, the Bank of Japan decided to adopt a negative interest-rate policy in the world’s third-largest economy, starting on 16 February of that year, with the aim of stimulating lending, raising the inflation rate, and reviving an economy suffering difficulties, in an exceptional move justified by market volatility at the time. That means depositors may not receive a return on their money, and banks will not receive a return on what they place with the central bank but will instead pay for it, which means that continued holding of such funds results in their value eroding over time, not because of inflation, but due to an actual deduction.

-        The Bank of Japan set its deposit rate at -0.1%, and it remains so to date, and together with Switzerland, which has a negative rate of -0.25%, and Denmark with a negative rate of -0.60%, negative interest rates are a tool aimed at penalizing banks that hold liquidity in their vaults instead of lending it. The central bank imposed the decision on some excess reserves that financial institutions hold at the central bank, unchanged at -0.1%.

-        The governor of the Bank of Japan said in 2017 that the bank would deepen negative interest rates or expand bond purchases if the economy faced external shocks that created a "large" need for further monetary easing — a term that means printing money. The Bank of Japan affirmed its readiness for further easing to preempt risks that would put negative pressure on the 2% inflation target, noting that the expected inflation rate in Japan for 2022 is 1% (The New York Times study dated 16-6-2022).

-        The countries that implemented that policy (negative interest rates), and which are major economies, justified it by saying it pushes banks to lend and addresses recession by creating monetary liquidity that contributes to market recovery. The European model is the most prominent in this regard because collectively it represents the world’s second-largest economy with a GDP estimated at $18.7 trillion annually after the U.S. economy. The European experience pioneered such policies; the European Central Bank announced, as the first major central bank in the world, that it was testing negative interest rates in June/June 2014, following central banks of smaller size such as the banks of Sweden, Denmark, and Switzerland.

-        In January 2017, the ECB announced a new set of measures in its monetary policy to revive markets in the euro area, lowering rates so that the main rate, the borrowing benchmark in the euro area, became zero and remains so to date — after having been 0.5%. That was the first time in the history of this currency bloc, meaning banks can receive financing from the ECB without cost. Consequently, banks must lower the interest rates they charge their indebted customers. It also means deposits in banks will yield nothing, which should prompt depositors to consume rather than save.

-        Central banks that adopt a "negative interest-rate" policy have cited the positives of this policy, especially in confronting recession, and their desire for inflation to reach 2% as a threshold for raising interest rates, but experts and heads of major central banks rejected this monetary policy. Several national leaders often state the importance of lowering interest rates, such as Donald Trump in the United States, considering that high interest rates alone do not protect against inflation, but they certainly lead to contraction of domestic investment and increased national debt.

-        Low interest rates and the ECB’s money-printing programs, known as quantitative easing, have distorted asset prices and reduced insurance companies’ investment returns, most of which are in bonds.

-        As for U.S. Treasury Secretary Steven Mnuchin, he commented on the ECB’s decision at the time to cut the deposit rate, saying that he "was not surprised by the ECB’s decision, but negative deposit rates in Europe are worrying because they make it difficult for the U.S. economy to grow.".....!!