THIS is the way the system is supposed to work: A government’s central bank loans money to a commercial bank at a “Goldilocks” interest rate. That means the interest rate is not too high to make borrowing too expensive and not too low as to encourage unnecessary and risky investments with the borrowed funds. Assume that ideal interest rate is 5 percent.
The commercial bank loans the money it borrowed from the central bank at a profit and to cover the risk of loaning the money. Individual borrowers might buy a new car or house or even a washing machine. All those purchases help grow the economy.
Companies also borrow money from the bank to expand and improve their business productivity and profits. That is good for the economy also. Jobs and wealth are created, which leads to more growth and productivity. But the normal business cycle of good and not-so-good times will always kick in and the government, in its wisdom, thinks that it can push the economy along, better than just letting the business cycle work its way out.
The central bank lowers interest rates to make it cheaper for people to borrow and buy things, and for businesses to grow. Theoretically, when the economy is back in the sunshine, the central bank is supposed to raise the interest rates higher back to the “Goldilocks” level.
The US Federal Reserve says that it has a formula that it will follow as to when to raise interest rates higher. This is dependant on US employment and economic growth. Of course it is the same formula we have heard about for six years and it never seems to be met. Job growth in the US is apparently fantastic right now. Except there are the same number of people working today as in 2007, even as the working age population is 15 percent higher. Economic growth is so great that this is the first eight-year period in the history of the US when there has not been a single year of 3-percent growth. The forecast for 2016 is 2 percent.
But the reason there will not be a return to “Goldilocks” rates is that to do so would bankrupt all the major central banks.
Combined with low interest rates was “Quantitative Easing” first used unsuccessfully during the Great Depression when the central bank “buys” government debt. The major central banks own $25 trillion of financial assets, an amount greater than the economic output of the US and Japan, combined. If interest rates are raised to “normal”, that debt would have to be liquidated. The problem is, who is going to buy it? The reason the central banks own it is because no one wanted to buy it before. Further, all this debt owned by the central banks is at virtually zero interest rate and will be worth even less if/when rates are raised.
The Group-of-7 central bank governors have been in their current posts for a collective 17 years, yet only one (Yellen in December 2015) has actually hiked interest rates during this time. Do not expect any significant changes any time soon.
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