The raising of interest rates by the United States Federal Reserve late last week is the best news in seven years for the world's economy. Tiny though the increase was, zero to 0.25 per cent on the US base rate, it is the first confirmation confidence is returning to at least one major economy since the global financial crisis. Most others are still on monetary life support. Long ago they lowered their base rate to zero and resorted to printing money ("quantitative easing") to maintain a stimulus for their economy.
It worked as Keynesian theory suggested, stopping the crisis from turning into a recession on the scale of the 1930s depression. But the theory, developed in the depression, is less clear about how an economy returns to normal. The experience of the 1930s provides little guidance. Seven years after the worst year of the depression, leading economies were stimulated by World War II. Fortunately, nothing like that is on the horizon today. Instead, leading economies have been drifting, barely recovering. Governments in Europe and Japan are afraid to wean their business sectors from quantitative easing and business is wary of investing in anything except solid property while their economy is sustained by artificial means.
The US Federal Reserve planned to start winding back its stimulus several years ago but backed away from doing so. Now it has taken the smallest step possible and remains wary of taking further steps. Even so, it could be the turning point, not just for the US economy but for the recovery of others. Business in the US is likely to draw more confidence from this first step towards normality. The US dollar is likely to rise, giving other currencies a useful devaluation, especially China's now its value is less tightly pegged to the greenback.
New Zealand, too, could use a lower exchange rate to help offset the slump in dairy prices. The kiwi's initial response to the Fed's move on Thursday was not what the Reserve Bank probably hoped. The currency rose slightly against the US dollar. That probably reflected the optimism implicit in the US decision.
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The lesson of the past seven years is surely that artificial stimulants can work against their intended purpose. They are supposed to give companies the confidence to invest for continued growth, but business is not fooled. It may be relieved that a recession is milder than it might otherwise have been but it knows the stimulant has to be withdrawn at some point. It is not a good basis for investing in productive expansion. Earnings go instead into savings, share buybacks and real estate. That has been the story of the past seven years in all developed economies.
If it had been suggested to proponents of quantitative easing in 2009-10 that major economies would still be relying on it five or six years on, they would have doubted it. But so it has proved. It is easier to put an economy on this drug than to withdraw it. The Fed has acted to lift inflation but it may find it has done much more. If the US now believes in its recovery, that confidence may prove contagious.