Inflation bad, deflation bad, high interest rates bad, 0% interest rates bad
Posted by markharrison on November 12, 2008
It’s hard to know what to make of the global economy, and the UK economy in particular, at the moment.
A few months ago, all the papers were worrying about inflation, how the cost of everything apart from DVD players was going through the roof, and how this spelt poverty for millions of Britons. We in the property world were worried about high effective interest rates, and mortgages being hard to get.
Now, you might have thought that if inflation was bad, then deflation would be good… and that if high rates were bad, then low rates would be good… but the truth is more complex than that.
Inflation tends to be frowned upon because it hits those who have assets… the money they currently have will be worth less this time next year. The obvious people are, say, pensioners with savings, who have seen that their savings didn’t go as far as they’d hoped. Less obviously, though, are investors – if you are investing in a country with an high inflation rate, then you need outstanding returns to make it worthwhile, and an awful lot of investors think globally (even in property – look at the invvestments in Spain or the US.)
Deflation though, is more subtle. What deflation tends to do is stop people buying. We all know that you should never buy a laptop before Christmas, but wait for the sales… or actually, that you will always get a better deal on such technology items if you wait… but what happens when everything goes down in price? Generally, people come to expect further price decreases, and buy less and less. The experience of Japan over the last ten years has shown us that this leads to companies going down the tubes since no-one will buy their products (they’d rather wait), and therefore jobs are lost.
Likewise, high interest rates tend to put the brakes onto house price rises… though in fact, “brakes” is the wrong metaphor, because if I put the breaks on in my car, it slows down… but doesn’t actually go into reverse.
Low interest rates are, likewise, more pernicious. The problem that Central Banks have is that it tends to be rate CHANGES that have an impact, not the absolute level of rates… so once a rate is at 5%, or 2%, or 0%, the market adjusts to the new level in response. The problem is that, if a rate’s at 5% you can tweak it up or down… if a rate’s already at 0%, you can’t reduce it any further.
So zero interest rates, while good for house buyers who time things right (though actual mortgage rates never go to zero), tend to be bad for economies, because one of the key possible actions that a central bank can use to get things going again is no longer possible.
The ideal for most people seems to be the combination of about 4-5% interest rates, with about 1-2% inflation. We know how to operate in those areas… anything outside tends to be uncharted waters, and the danger is that while some will make a lot of money while gambling right, others will get wiped out – the uncertainty increases the risk.