So now, it has come to pass that the United States at last has decided to raise the interest rate. It does not matter whether this means a turning point for the interest rate. What matters is that it is supposed to soften aggregate demand in order to ensure that the inflation of prices does not continue at a high pace.
The real concern is whether it is possible to do a soft landing for the economy or that this little move may trigger an avalanche of the collapse of the global economy.
The world is waiting for the money supply to be destroyed or reduced after having printed so much in the last three decades or so. The excess money supply is created by historic debt owned by governments and households while transnational corporations and the corporate world owned all the profits thus generated. Except probably for the surplus countries which inevitably ended up holding all the money printed by the United States. So the global and the individual national debt issues are waiting for an adjustment because there must be a mechanism for aggregate demand to be softened so that demand pressures will ease off and prices will not continue to accelerate.
A rise in the interest rate means (a) that bank loans will not grow as fast as before because loans have become more expensive and there are not that many projects that are lucrative enough. New bank loans mean new wages and new profits, and few bank loans mean no rise in wages and lesser profits. (b) Old loans are now have higher interest payment and this eats into disposable income. (c) Of course, savers now enjoy higher interest income and this is good for them as it helps savers to maintain their standard of living or otherwise save more to earn interest income. However, most of the savers are corporates so they may have a way to offset some of their lesser profit. But many companies with huge debts because of their previous expansion spree are now caught with cashflow problems.
I am not trying to scare anybody about the plight of the economy when the interest rate rises. I am merely trying to describe a scenario of how a rise in the interest rate will bring about a softening of the aggregate demand and hence the growth of the economy so that there is less pressure on prices and hence helping to soften the blow of inflation.
The challenge in thinking now is whether the multiplier will now work in reverse and hence trigger off a spiraling collapse of the economy, well, the world economy. Is there anyone who is safe from this? The oil exporters may think they do not have a problem because they have all the cash from the high oil price. Since the policy goal is to stop the oil price from climbing, a collapse of the global economy may see a crash also in the oil price, given that the oil price is usually highly speculated and traded on. Of course, we have not detailed how the stock markets and the commodity markets will react.
My purpose is only to describe what to me is something that is quite plain to see. Of course, we hope things will go according to the plans of the policy makers, then everything will be good. But do not be surprised when markets decide to act according to their own natural market laws. We can only be prepared, if nothing, at least, mentally.
