There are fashions in economic indicators, as there are in designer clothes and management consultancy. Today, markets are obsessed with interest rates and house prices, while other microeceonomic factors are hardly debated.
A few weeks ago, I took part in a debate about European and American business models. Was the European social market viable? Why had market economics generated so much more prosperity than central planning? How could successful market institutions be transferred to poor countries?
The argument was stimulating and productive, and I was pleased when five journalists came up afterwards to greet the panel. But I was miffed when they brushed past me. They did not want to talk about America’s structural deficits or Europe’s deteriorating demography, about why sub-Saharan Africa is poor or why China is growing so rapidly.
The journalists were there because one of the participants was a member of the Bank of England’s monetary policy committee. The scribblers had sat through two hours of discussion of global economic issues in the hope that my fellow panellist would hint whether he would, or would not, support a quarter-point rise in interest rates. Disappointed, they hoped that an unguarded private moment might still make their attendance worthwhile.
If you read the economic pages or watch business television, you gain the impression that these decisions by the Bank of England, the US Federal Reserve and European Central Bank are of vital importance. For months now, there has been speculation that the interest rate cycle has turned. The Bank of England has now raised rates three times. When will the Fed follow suit? Will rates reach their peak in September, or not until next year?
As if it mattered. Our debate had considered why West Germany had done so much better than the East. The record of the Bundesbank in managing monetary policy from the establishment of the D-Mark in 1948 to the introduction of the euro in 1999 is probably the most impressive achievement of central bankers anywhere. Yet no one even bothered to suggest that the difference in performance was the result of interest rate policy. Other government policies – state versus private ownership, competition versus monopoly, the structure of property rights, systems of education and training – mattered far more. But these microeconomic influences are barely debated in financial markets, while even the rumour of a variation in interest rates can change perceptions of the value of companies by billions of dollars.
Interest rates influence business investment and consumer spending. But usually not by much. A recent survey by the ECB suggests that in Europe a quarter-point increase in interest rates might reduce consumption by up to a tenth of 1 per cent, and business investment by a bit more – perhaps as much as 1 per cent over three years. These modest responses are what we should expect. There are not many business investments that are attractive if interest rates are at 2 per cent but unattractive if they are 2.25 per cent. And credit charges are only loosely related to money market interest rates.
Very big changes in interest rates do have a substantial impact. Consumers and businesses tend to plan on the basis that the future will not be very different from the present. If that expectation is disappointed, severe distress may result. Sometimes it is necessary to create these abrupt shifts, as in 1980, when Paul Volcker’s policies helped end the era of accelerating inflation. But more often, as in Britain in the early 1990s, or the US in the years to come, disruptive changes in economic policy are the consequence of inept management. These damaging episodes are best avoided. This is what Mervyn King, governor of the Bank of England, meant when he said his objective was to make monetary policy boring, and he has been reasonably successful in achieving this result.
But the behaviour of these journalists suggests he has not yet been successful enough. There are fashions in economic indicators, as there are in designer clothes and management consultancy. I can remember when the monthly balance of payments statistics were often the first item on the television news. At other times, the monthly inflation rate, the unemployment figures and the money supply have been the centre of attention. Today, markets are obsessed with interest rates and house prices. In the topsy-turvy world of those who trade securities, things matter if other people think they matter. That does not mean they really do.