The Business Times

An economy needs a price mechanism to work

Published Mon, Mar 28, 2016 · 09:50 PM

FEDERAL Reserve chair Janet Yellen speaks in New York on March 29. She is caught between the devil and the deep sea, but needs to lay a course - and a convincing one - for US monetary policies. It should feature future but modest interest rates hikes. Here is why.

Economic policies worldwide are in an impasse. Deficits and debt gained ground prior to the global financial crisis when countries borrowed instead of saving for rainy days. When fiscal stimulus was brought in to stimulate demand, debt and deficits accelerated, worsening the situation. The global economy did not take off. Unfortunately, the high - close to all-time-high - debt narrowed the room for manoeuvring in fiscal policy. The task of getting the economy underway shifted to central banks pumping liquidity into the economy hoping to see rising demand, production and employment. No luck either.

Monetary policies reduced the burden of servicing the debt through first, extremely low and then negative interest rates. This removed the incentive for the debtor to pay back debt - why do so when there are no costs in rolling it over? The creditor was not reaping the remuneration associated with lending money. Lending and borrowing, vital for oiling the economy, stopped. All sectors in the economy watch each other knowing that sooner or later this will stop, interest rates will begin to rise and there will be a burden to distribute as debt repayment starts.


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