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Interest rates: Saviour or villain?

Khaleej Times logo Khaleej Times 10/02/2019 Rajeev Kakar
Interest rates: Saviour or villain? © Provided by Khaleej Times Interest rates: Saviour or villain?

With the business world focused on the Federal Open Market Committee's (FOMC) meeting last month, it is important to note that, after four rate hikes in 2018, economic data reflects weakness in equity markets, oil prices and global growth. With Fed rate changes now being data-dependent, rates are unlikely to rise in near future.

Monetary management is a difficult act as outcomes of central bank policy changes are often unexpected. It is impossible to estimate the correct supply of money in an economy, as nobody precisely knows the real state of the economy at any time. Decisions are based on ambiguous and time-lagged data, exacerbating problems as increasingly various governments meddle with money supply and interest rates for different political or social reasons, countering conventional economic approaches.

With cross-border flows rampant, such misaligned actions of multiple central banks compound unpredictability. A solution for one economy often causes a pain in another market - as economies are no longer uncoupled. With countries over-leveraged in debt, demand is slowing. With years of monetary stimulus offering low-cost funds, the system capacity has surged and such demand-supply misalignment further aggravates issues.

Conventional economics suggests that, ideally, money supply should expand at a rate equal to the fixed long-term growth of a nation's output to maintain equilibrium, as steady supply growth would match the economy's growth trend. This theory is based on the premise that a nation's normal economic growth rate should be in line with its stable capacity to produce goods and services, reflecting its long-run capacity of increasing productivity.

However, problems are caused by interventionist governments and economists who provide boosts or curbs, to artificially alter economic performance. Without unnecessary intervention, economics would work on its natural dynamics to drive safe growth in the system. However, manual overrides of this natural economic phenomenon leads to unanticipated outcomes.

The fact is that we have irreversibly disturbed the global equilibrium offered by traditional 'hands-off' economics that allows economies to follow their stable and sustainable growth rate. It's increasingly difficult for the Fed to decide on policy actions as 'traction and transmission' effects of these actions are harder to gauge owing to conflicting interventionist approaches. Central banks are often at a loss to decide on what to do, how much to do, how to be effective, and in estimating how actions of other central banks will affect their policy outcomes.

So what should businesses do in our world of such man-made perfect imperfections? Businesses should be aware that they operate in a world of excessive information, available on fingertips, but often too sensationalist, biased or even false. The willful suspension of belief in such biased news for taking actions is the most prudent way to run businesses. Businesses decisions should be based on an entrepreneur's sensible assessment of long-term fundamentals. Businesses must avoid being swayed by short-term interventions, shun greed, avoid excessive leverage and maintain adequate liquidity to isolate against inevitable cyclical shocks.

Businesses need to be smarter and remember that while economics is integral to society, it is the human being who is the essential link between macro and micro economic trends. Humans create societies, build them on collective values, and form institutions that take actions to influence their future. The varied cultural influences of multiple societies influence the effectiveness of policies differently. No single government can offer the perfect solution in our interconnected world. An alignment of efficiency, speed and good judgment is needed for right impact which is difficult to achieve.

So, as the FOMC convenes on rate actions, it is hard to say whether interest rates are the saviour or the villain. Money supply in the right dosage is undoubtedly essential for an economy, but imperfections in the art of dispensing the dose by practitioners have made its impact unpredictable. It is, therefore, unwise for businesses to depend on modern day economics, which is interfered with and incorrectly based on implausible statistics on how people live and think.

In today's world, beware of so-called experts and consultants who use biased statistics to play tricks on the human mind. As Wodehouse so aptly quoted, "some minds are like soup in a poor restaurant - better left unstirred".

And, if I may add, better ignored.

The writer is founder of Dunia Finance, co-founder of Fullerton Financial Holdings and former Citibank regional CEO of the Turkey-MEA region. Views expressed are his own and do not reflect the newspaper's policy.

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