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Friday, August 22, 2003

Interest Rates and Demography

Well, as usual, I no sooner open my mouth than I get sidetracked. As Big Arny said, never say never. In Brazil the interest rates are coming down:

Brazil's central bank yesterday cut its prime lending rate by 2.5 percentage points to 22 per cent, the largest cut in more than four years. The cut exceeded market expectations of a 150 basis point reduction and is likely to assuage critics who argued the central bank had been too conservative in easing monetary policy. It was the third consecutive monthly interest rate cut. Economists say the cut was possible because of successful inflation control in recent weeks. Consumer prices fell by 0.15 per cent in June and grew by only 0.2 per cent in July.
Source: Financial Times

Taking another, similar example, Turkey also cut rates in early August.

Turkey’s Central Bank has announced a three point reduction in short term interest rates. The reduction, announced on Wednesday, covered rates for the Interbanks Monetary Market, the Istanbul Stock Exchange (IMKB) and Repo-Reverse Repo Market according to the Central Bank statement. With the reduction, the borrowing interest rate was decreased from 35 percent to 32 percent and overnight lending interest rate was reduced from 41 percent to 38 percent. The rates for one week borrowing was reduced from 35 percent to 32 percent. The Central Bank cited continuing positive trends in rate of inflation and the ongoing success of the government’s economic restructuring program as being the major factors in the decision to cut interest rates.
Source: MSNBC

Now what's the point here? Well look at the rates: Brazil goes from 24.5 to 22, while Turkey goes from 35 to 32. Meanwhile Japan is at zero and the US at 1%, why the enormous difference? Well hyperinflationary tendencies for one thing. Rates in Brazil and Turkey (and I pick these two countries for their rough equivalence in the 'demographic transition') are where they are in order to put a firebreak on the inflationary tendencies of the two economies. When I came to Spain 15 tears ago mortgage rates were in the high teens, now you can find a mortgage here for !% over MIBOR, or roughly 3- 3.5%. Why the big difference? Well clearly rates in Spain are artificially low due to the common currency (and this, of course, has produced a spectacular housing and construction boom: one curious detail, house prices don't figure in the EU HICP, if they did Spain would have a rather higher rate of inflation, but construction activity does figure in GDP calculations, so it may be this fairly undesireable inflation-provoking excess - and not that marvellous sounding Harrod-Samuelson-Balassa effect - which accounts for Spain's 'mini-boom' growth differential. Watch this space for more news). But even if mortgage rates were at a more appropriate level, they would only be a few percentage points higher. So Spain has been able to make a remarkable reduction in interest rates over the last twenty years, and one of the big, big questions is why? How do you get those rates down?

The IMF approach has been to try and impose a fiscal and currency straightjacket. For this it has received a lot of criticism, but not all of this is justified, (and here ). My own feeling is that this needs to be a lot more flexible than it has been. If Malmberg is right, and countries like Turkey and Brazil are making the transition from child dominated to young adult societies (Spain in contrast has made the transition from young adult to middle age in the last twenty years), then this needs to be understood, and more imaginative measures need to be found to help them ease the pain. Remember the characteristics of this transition are a still large dependent population, low saving and large cohorts entering the labour force (it is this which creates the fiscal deficit pressures and the inflation-push). At the same time 10, 15 years from now these societies could be extremely credit-worthy, the problem is to find a mechanism to bridge this gap. Mind you, the IMF has learnt something: both the Turkish lira and the Brazilian real are floating.

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