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interest rate

As predicted by many economists like Peter Schiff, central bank interest rates around the world are beginning to rise, or are predicted to rise in a controlled manner in about 2 years’ time according to the bank of Canada’s assessment of its countries’ economic conditions until 2011 according to Helmut Pastrick, chief economist with Central 1.

2.5% bank rate by 2011: Economist

The Bank of Canada will push its benchmark interest rate to 2.5 per cent in the next year and a half, an economist with the Central 1 Credit Union predicted Friday.

The rate is now at 0.25 per cent and the central bank has said it will likely stay there until the spring of 2010. Helmut Pastrick, chief economist with Central 1, told CBC News the recovery remains on track, with only occasional data suggesting a setback.

Much of the growth will have been the result of government stimulus, especially low interest rates, Pastrick admitted but predicted the private sector would jump in with increased investment and job creation

“Over time, the private sector begins to take the main role in economic growth and that should play out this time as well. However, it appears that it’ll be more of a longer drawn process particularly in the U.S. since there’s still some ongoing problems in credit markets,” he said.

Once the recovery is underway, he said, the central bank will be anxious to move away from rates near zero. Pastrick predicted the bank will likely raise rates by half a percentage point at a time perhaps three times through the fall to spring period from 2010 to 2011.

“That would allow them some room to cut rates at some future point should the economic recovery falter.”

Original story appears at CBC News

What is the problem with his predictions?

First of all the piece provided by CBC is shoddy journalism at its best because the bank rate is not the prime rate. The bank rate is already at 2.5%; the prime lending rate is at .25%

According to Peter Schiff and the austrian school of economics, “the reality is, that if we put interest rates anywhere near where they ought to be, we would bankrupt most of our financial entities and we’d have a real collapse. We’re never going to have a real recovery until the market lets us have a real recession. Our phony consumer-based economy isn’t viable; it only exists as long as the Chinese and Japanese lend us money to buy their stuff.”

The reason for this setting is that Keynesian economic planners believe that it is their duty to manipulate interest rates which ultimately affect the market in the long term, but to manipulate them for short-term gains in the economy. Typically a central bank controls certain types of short-term interest rates. These influence the stock- and bond markets as well as mortgage and other interest rates. The European Central Bank for example announces its interest rate at the meeting of its Governing Council; in the case of the Federal Reserve, the Board of Governors (Wikipedia, 2009).

Also, all the people with the half million dollar mortgages at 2 percent won’t feel too comfortable if the rates to up to 4.5 per cent.  This would be an automatic recipe for disaster, and another housing collapse similar to what we saw in the early 80s.  Disasters like this could be averted if the central bank would stay out of the economy and out of the business of setting interest rates.  They set them artificially low, and then the economy suffers because of it due to re-adjustment.

Low interest rates tend to stimulate borrowing from the banking system. This expansion of credit causes an expansion of the supply of money, through the money creation process in a fractional reserve banking system. This in turn leads to an unsustainable “monetary boom” during which the “artificially stimulated” borrowing seeks out diminishing investment opportunities (Wikipedia, 2009). This is where the world finds itself in trouble now that interest rates were kept too low for too long. World economies are now feeling the effects of excess liquidity in the markets.

interest rate chart

The article’s economist’s optimism is surprising, since many economists are pointing out that the recent bit of good news is largely the result of government stimulus which won’t last forever, and there’s little to suggest the private sector will pick up the slack anytime soon. In addition, those few economists who correctly predicted the big US housing meltdown/credit crunch are now saying there is another round of trouble coming as banks foreclose on homes that belong to long-term unemployed people in the US, and another batch of sub-prime and other “special” mortgage deals come up for renewal at higher rates.

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