A Good Rate Hike for Europe

History shows that rising inflation is eventually followed by higher nominal interest rates.

An expectation that interest rates will be high sometime in the next decade should mean high interest rates on long term bonds today.

Do Low Interest Rates Ensure High Asset Prices?

Central banks respond to lowered demand by reducing interest rates and to higher expected inflation by raising interest rates.

A higher rate of expected inflation would also cause the total nominal rate to be greater than 5 .

In this case, the price of loanable funds is the real interest rate. An expectation that interest rates will be high sometime in the next decade should mean high interest rates on long term bonds today.

But interest rates have been increasing around the world since 2003.

Such circumstances include, first, a high debt GDP ratio, with rising interest rates impeding growth.

The second adverse effect of deflation is to raise the real interest rate, that is, the difference between the nominal interest rate and the rate of inflation.

Although it is difficult to anticipate how high long term interest rates will eventually rise, the large budget deficit and the rising level of the national debt suggest that the real rate will be higher than 2 . A higher rate of expected inflation would also cause the total nominal rate to be greater than 5 .

A hike, in other words, would indicate that good things are happening.

Moreover, the deficits would mean higher interest rates and continued international imbalances.

In addition, a fall in the dollar could also push up inflation in the United States, leading to higher American and global interest rates.

But interest rates on US Treasury securities are very low and are not rising.

Unemployment is rising, their economies are not becoming more competitive, and the interest rates on their debt continue to rise.

With European interest rates up 200 basis points since late 2005 and the euro near a record high, Sarkozy wants the ECB to stop raising rates now.

This will change, however, once the economic pick up is confirmed. Interest rate hikes may be coming sooner rather than later, which is why Berlusconi and French President Jacques Chirac are talking up interest rate cuts now.

With higher interest rates depressing housing prices, the game is over.

No matter how high rates go, they think they re behind.

Corroborating statistical evidence shows that high deficits and debt increase long run interest rates.

And that is important, because a rise in the federal funds rate will cause other, somewhat longer interest rates to increase as well.

Remarkably, as short term interest rates rose, medium and long term interest rates did not, something that was referred to as a conundrum.

But higher energy prices, by themselves, will not cause the ECB to pull the interest rate trigger.

Either way, a rise in long term interest rates is liable to choke off the recovery.

The euro is at record levels, oil prices are surging and interest rates are expected to go higher.

Ordinarily, a sharp rise in oil prices quickly translates into higher inflation expectations, followed by rising interest rates at all maturities.

The result in Japan would then be rising real interest rates as the low private saving rate runs head on into large fiscal deficits.

Inflation implies higher long term interest rates until markets regain confidence in the central bank.

Those experiencing rising and now double digit inflation will have to raise interest rates, while other high inflation countries will lose export competitiveness.

Thus, they run the risk that a spike in interest rates would feed back relatively quickly into higher borrowing costs.

Because the downturn was not caused by high interest rates, lowering them could not lift the economy out of recession.

Higher international interest rates and a repeated lowering of the exchange rate made servicing the external debt more costly in terms of the national currency.

Higher interest rates also raise the cost of borrowing to buy these assets, which may diminish demand for them, exerting downward pressure on their prices.

But lower short term interest rates have led to higher medium term interest rates, which are more relevant for the mortgage market, perhaps because of increasing worries about inflationary pressures.

But, with longer term interest rates now creeping up slightly, the BOJ seems to be pausing. What did Kuroda and his colleagues expect?

Although it is difficult to anticipate how high long term interest rates will eventually rise, the large budget deficit and the rising level of the national debt suggest that the real rate will be higher than 2 .

Within a couple years, interest rates on long term US Treasury notes could easily rise 3 4 , with interest rates on other governments paper rising as much, or more.

Lower demand for Greek debt caused its price to fall, meaning that its yield in terms of market interest rates rose.

Over the past 25 years in Europe, unemployment rose as monetary policy was tightened and interest rates were raised to fight inflation.

One reason for a rise in the interest rate would be a shift from low deflation to low inflation.

We might also be looking at a potential ratings downgrade for US government debt implying the prospect of even higher interest rates.

First, while the US Federal Reserve continued hiking short term interest rates, long terms rates did not increase in tandem, which allowed housing prices to continue rising.

Back then, Europeans complained that low interest rates in America were driving global inflation now low US interest rates are blamed for driving irresponsible asset price booms.

But the public often views interest rate increases as negative events that increase unemployment and stifle growth. Blame game politicians like Berlusconi, who have failed to put bread on the table, their minions in the media, and Keynesian economic professors who don t understand and misrepresent Keynes sustain this distorted view.