WES Presents: Dr Sushil Wadhwani

Posted on the 19th November 2015 by Sumeeta, Communications Coordinator

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Warwick Economics Summit (WES) gave an official start to its 2016 project by launching the first WES Presents speaker event of the year on 17th of November. WES was honoured to host Dr. Sushil Wadhwani, CBE, a distinguished scholar, economist, and investor who delivered a speech on a highly topical issue 'The Outlook for Interest Rates’.The event provided a range of students with a more detailed understanding of the subject and its current developments as well as giving them a brief insight into the upcoming Summit.

Professor Wadhwani aimed to cover the questions that recently became broadly debatable among the distinguished economists or the policymakers and provided his own view.

Is secular stagnation the new norm?

Dr. Wadhwani was unequivocal and explicit calling the secular stagnation a “sinister possibility” in the future economic arena of the most influential economies, in particular pointing at the US. In the simple words of the professor, the concept of secular stagnation comprises a view that the economies might find themselves in a position where they are trapped in a low-level equilibrium with weak demand. Sadly, this is exactly the direction that the economies are moving to.

Have central banks run out of ammunition?

Dr. Wadhwani referred to the ‘few obvious’ regarding this question. Firstly and the most importantly, interest rates are incredibly low at the moment. Secondly, interest rates have been following the trends of unusual lowness for a long time.

The reasoned question that arises from these tendencies is “why are interest rates kept so low?” The explanation provided by the professor combines both textbook models and real-life effects. A cut in the interest rates was an aggressive response to the global financial crisis dating back to 2007. This widely-accepted central bank policy aimed at stabilizing the biggest economies and their financial systems after a prolonged economic downturn.

In the textbook cases, low interest rates are expected to increase demand for investment or alternatively reduce demand for savings…or a bit of both. However, the low interest rate outcome was hindered and the professor proposed a reasoning behind this counter-development. In his view, financial crisis “came as a shock” to many people. Following that, they became much more precautious. This translated into higher consumer propensity to save globally. Businesses increased their risk aversion as well in the wake of financial uncertainty.

The failure of the economies worldwide to generate growth and close output gaps seems to restate the old truth that “the economies are not performing in line of what the models say”. This realization lead to the rise of more profound policy debate. What is left in the low interest rate regime? Should the economies descend into the lands of negative interest rates? Dr. Wadhwani did not provide an absolute answer to these dilemmas. However, he stressed that the negative interest rates did not seem to have any effect, neither negative nor positive in the countries that have already adopted it. Switzerland with its -0.75% interest rates was only one of the examples provided. Therefore, the ammunition of central banks seemed to not be effective after the post-crisis years. However, there is little that could be done because “interest rates will remain very low for many more years to come if the secular stagnation hypothesis is correct”.

Will the Fed finally raise rates in December?

Almost certainly YES. This Dr Wadhwani’s personal belief had been reiterated for several times during the talk. He stated that it would be risky for the Fed not to make this move. Why? The professor provided an explanation based on the historical US unemployment rate data. Five years ago, the US unemployment rate fluctuated around 10% and extra spur [low interest rates] for the economy was needed to reduce these levels and make use of the spare capacity. However, today the US faces an unemployment that is somewhat close to 5% - the state that the economists agree to be natural rate of unemployment. Low interest rates and ever-falling unemployment could trigger inflation to the dangerous levels, something that the Fed wants to avoid.

Dr.Wadhwani stressed that the Fed is preoccupied with the possibility of rising inflation even if this is not what is going to happen. Thus, he concluded that he would be surprised if the US interest rates were not increased in December 2015… and twice again in 2016.

POLL RESULTS

Before the talk ,we had asked the audience to respond to the poll question “When will the Federal Reserve increase the interest rates?“. It was rather interesting to note only around 22% of the audience thought that it is likely to happen on December 2015. We hope that Dr. Sushil Wadhwani’s insightful and constructive talk geared the audience to view the current economic situation from different angles and assisted in forming their own opinion regarding the outlook of interest rates.

By Ieva Zvinakyte, Communications Team Member

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