Friday 21 October 2016

Why the US interest rates hike will be good news for Irish exporters

Published 17/12/2015 | 02:30

Women pose for a photograph next to a homeless man outside Moynihan Station in New York. The US Federal Reserve has increased interest rates for the first time in almost a decade. Photo: Reuters
Women pose for a photograph next to a homeless man outside Moynihan Station in New York. The US Federal Reserve has increased interest rates for the first time in almost a decade. Photo: Reuters

The 21st century has been of two halves economically. Before the western world's financial mega bubble burst in 2007-08, things were much as they had been for decades - decent if unspectacular rates of growth in most countries, near continuous increases in the numbers at work and, when recessions struck, they were short and shallow.

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Then came the Great Recession. The developed world has not returned to its past normality, nor even found a new normal.

Two big things illustrated that this week - employment in Europe and interest rates in America.

On Tuesday, Europe's jobs numbers were published. In the July-September period, 230 million people were are at work across the 28 countries that make up the EU. The news on jobs was good - a big majority of countries is now experiencing rising employment.

But the bad news is that the numbers who have a job across the continent are still 1.5 million down on the pre-crisis peak, recorded exactly seven years earlier.

That employment remains below its peak over a period as long as seven years is unique in the post-World War II era, and underscores just how much damage financiers can cause when they get out of control, as happened across the developed world in the period leading up to the crash.

If we in Europe have had our woes since the great crash, the place where it all started has done only a little better. While there are now more Americans at work than in 2008, that is only because there are a lot more Americans - population growth in the US is much higher than in Europe.

Illustrative of the long-term impact of the Great Recession in the US is the fact that the share of adult Americans at work is still well below the pre-crisis peak.

Just before the meltdown began in the US, more than two-thirds of American adults aged 25 and older were in jobs. The share of adults at work then plummeted.

As of today, only around one quarter of the post-crash loss has been clawed back.

But because the US does not have the same sort of social safety as Europe, many people who are in long-term unemployment simply give up looking for work and leave the labour market.

That means they don't show up in the unemployment numbers, which are now indicating that there is almost no joblessness left in America.

All this suggests that the traditional measure of unemployment is no longer what one needs to watch when it comes to the US.

This is one of the reasons many economists were looking fretfully towards Washington DC yesterday.

On Tuesday afternoon, central bankers in the US capital were preparing to make one of the most eagerly awaited economic policy decisions in many years.

At 7pm Irish time last night, they announced the first increase in interest rates in almost a decade, raising the cost of borrowing from the near zero level it had been at since the crash.

Before discussing the implications of this for Ireland and the rest of the world, pause to consider how unusual the past seven years have been when it comes to the behaviour of central bankers.

Since interest rate records began centuries ago, never has the cost of borrowing been so low and for so long. That central banks across the rich world, from Europe to Japan to the US, have kept rates at as close to zero as makes no difference for seven years is indicative of how weak the developed economies have been in the wake of the financial crisis.

Is the US economy strong enough for the demand-sapping effects of higher interest rates?

This is the trillion-dollar question that has been exercising the minds of policy makers and economists across the world over most of 2015. And, as usual with such questions, there is little consensus because nobody can know for sure.

One argument against raising rates centres on the failure, discussed above, to return to normal in the labour market.

A second big reason against higher rates in the US is prices. Historically, central banks raise rates when consumer price inflation shows signs of taking off. But as inflation is as dead as a dodo at the moment, that is no justification for action.

A third argument made against a rate hike is that it might start a panic in financial markets. This is the weakest argument.

While financial panic would be undesirable if it negatively affected the real economy (and that doesn't always happen), the money men have got too used to borrowing for almost nothing. That has almost certainly created some new bubbles in parts of the financial system.

An important argument in favour of raising rates is that it could prick those bubbles before they become too big to cause real damage.

Provided the move to raise interest rates by the US central bank does not slow growth in the real economy in America, we on this side of the Atlantic have little to worry about. Indeed, we stand to benefit.

Higher interest rates in the US will cause hot money to flow into that country, pushing up the value of the dollar. That means, by definition, a weaker euro. Though a weaker currency comes with the downside of more expensive imports, the upside is that it makes exports cheaper.

And because Ireland sells so much to the US and Britain, our exporters stand to gain more than most in the single currency area from a weaker euro.

Here's hoping it will contribute to a stronger recovery on this side of the Atlantic.

Irish Independent

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