Hossam Dan: Are central banks too hawkish?

Opinion:

Central banks run the risk of causing an unnecessarily hard landing by raising interest rates too high and too quickly.

They seem to be reacting to the intense pressure of a frightened older generation
Back to the inflationary days of their youth.

But if central banks overdo it, the economy will collapse and the younger generations will suffer.

We are now in the most dangerous part of post-pandemic recovery.

The financial markets are obsessed. Commodity markets are not much better.

Small bits of news that doesn’t tell us anything new – like a US Federal Reserve official’s assertion that inflation is bad – have big implications for sentiment.

One day Wall Street was up 2 per cent and the next day it was down 2 per cent. This is not a healthy market behaviour.

The volatility highlights the risks that the US Federal Reserve could exaggerate and lead to a collapse in financial markets and a global recession.

Economic narratives used to take hold and escalate until they are no longer well-founded.

There is a good argument for this happening in the wake of the first Covid.

The global pandemic was unprecedented in living memory, and assumptions were made about what it could do to economic demand.

The scary narrative prevailed, which – in hindsight – led to too much motivation for too long.

While there was a clear need for a quick end to monetary stimulus and a sharp rise in interest rates, the momentum is now so tight that we risk an over-correction.

Central bankers engineer an economic downturn to rebalance supply and demand.

It’s a complex piece of economic surgery that, as usual, they have to do with a hammer.

We need to see inflation peak and ease.

But a financial meltdown, or a deep recession, would be a disaster in a world where pandemic stress has spread society into a dangerously fragmented region.

You can see the scenario unfold with ominous predictability.

The US Federal Reserve is raising interest rates by 75 basis points, and last week the Reserve Bank of New Zealand revealed that it is considering doing the same.

Interest rates have already been raised at an unprecedented pace in the past 12 months.

In New Zealand, we saw eight straight hikes – five of them by 50 basis points.

Another 50-point increase in November is almost certain, which will raise the liquidity ratio to 4 per cent – the highest level since the global financial crisis.

But since most people have had stable mortgage rates for a year or two, we’re only just beginning to see the impact of these hikes on the economy.

According to the latest Reserve Bank numbers, the average flat rate mortgage was just 3.68 percent as of August.

This suggests that almost all of the real interest rate pain still lies ahead.

First, higher rates must hit people out of pocket, dampening economic demand and then flowing through inflation.

As we await hard data on inflation later this month, economists are looking at more accurate information for clues.

There were some indications that the current inflation cycle was peaking.

The ANZ Business Outlook, the NZIER Quarterly Opinion (QSBO) and the SEEK NZ employment report all indicate that capacity pressures in the labor market are beginning to ease – albeit slightly and from record high levels.

As a key comment on QSBO, Christina Leung, Director of NZEIR, noted, “Business is beginning to see some light at the end of the tunnel.

A reader named Ian wrote to me.

“Hey, I’ve worked on railways for 40 years and we were always worried that the light at the end of the tunnel could be a train coming in the other direction.”

This briefly summarizes the risks here and around the world.

The economy at the moment is actually a good one for young people who don’t have mortgages yet.

They have jobs and career mobility. They use that mobility to develop themselves and their earning power.

Wage growth is ahead of inflation, which was 8.7 percent.

That’s not because companies offer up to 8 percent of annual wage assessments — but because young people are able to transfer jobs and get promotions.

This is clearly not a good economy for us seniors, who do not have the same levels of career mobility and the ability to increase our income.

What worries me is that older people dominate the political and economic narratives.

Calls for a tighter central bank policy show an underappreciation of higher employment and the long-term benefits it brings to the next generation of New Zealanders.

As a quick reminder, all things hawks and doves are borrowed from the language of foreign policy – as it relates to the desire for aggression and war.

War hawks, peace doves.

In economics, it is all about the money supply and attitudes towards inflation.

The hawks support higher interest rates and a more aggressive anti-inflation stance, and the doves are more relaxed about inflation and generally argue for leaving rates low.

I doubt anyone who sees them consistently in one camp or another, as I am one of the more tribal people on the left and right of the political spectrum.

I have been feeling increasingly stressed out for about 18 months now.

But it seems that it is almost time for the hawks to breathe a little through their noses (or their beaks).

Via Tasman, we saw the Reserve Bank of Australia do this last week, surprising the market with a smaller than expected 25 basis point lift.

RBA Governor Philip Lowe may also be skeptical about the light at that end of the tunnel.