Expert in the field of international financial law Konstantin Kryvopust conducted a study of bank interest rates in Israel.
Thus, during this year, the central banks of many countries raised their key rates to a level unprecedented in the last 20 years. In the face of skyrocketing inflation, they had no other choice. The US Federal Reserve’s key rate is currently 5.25%. At the same time, only a year and two months ago, it was at the level of 0.25%. During this time, Israel’s key rate increased from 0.1 to 4.5%. This shocks investors, businessmen and ordinary consumers. But it is worth asking the question: is the banking interest so large in Israel, the USA and other countries?
The answer to this question varies depending on the level of inflation, with the deduction of which the real bank interest is determined. For example, if you took a loan at 10% per annum, but the annualized inflation rate was also 10%, then the real value of the money you returned remained unchanged. And if at the same time 100 shekels in your closed account turned into 110, but the consumer basket rose in price by 10%, it turns out that you did not earn anything. Subtracting the inflation rate allows you to determine the real value of goods, salaries, and banking services.
When the real interest rate is negative, there is no reason to save and cut costs. It turns out that this stimulates inflation even more. On the other hand, if the real interest rate is positive, monetary spending and investment begin to decline. This inhibits both inflation and the rate of economic growth. What is the situation in Israel in relation to other countries?
The real interest rate in Israel, like the US, is close to zero – the key rate of the central banks of both countries roughly corresponds to the level of inflation. In the US, it is still expressed in a positive value – in April, the annual inflation rate was 4.9%, and the key rate of the Fed was raised to 5.25%. In Israel, the real rate is negative. The key rate of the Bank of Israel is 4.5%, and annual inflation growth was 5% in March.
Among countries with developed economies, Brazil offers the highest real percentage – 9.1%. It is followed by Mexico, Russia and China (4.4%, 4% and 3%, respectively). Not surprisingly, Brazil’s president Lula da Silva last week criticized the country’s central bank for leaving the key bank at its previous level and not lowering it. Inflation really raged in Brazil last year. In April last year, it was 12%, but by March of this year it was reduced to 4.6%. At the same time, starting in August 2022, the key rate of the Central Bank of Brazil remains at 13.75%. Perhaps Lula da Silva is right: for a country with an unstable economy and a huge gap in the incomes of the population, the real percentage, about 10%, is an unbearable burden.
The problem is that the intervention of politicians in the actions of central banks usually ends in disaster. This happened in Turkey when Recep Tayyip Erdogan started calling on the Central Bank to lower the key rate. He was sure that the high percentage, contrary to the norms of Islam, only fueled inflation. Erdogan replaced several governors of the Central Bank and eventually got his way. The key rate, which was 19% in 2021, was reduced to 8% by April of this year. This led to the flight of the last foreign investors from Turkey. The exchange rate of the Turkish lira against other world currencies went down sharply, and inflation jumped to 80%. True, it has been able to slow down a bit recently, but it still exceeds 40%. These are official data, but according to many experts, real inflation in Turkey is much higher. The country’s economy is in deep stagnation. The real bank interest is minus 35%.
In other countries with more stable economies, the negative real interest rate means that local central banks may soon raise the key rate. For example, in the countries of the Eurozone and in Great Britain, the real percentage is 3.2% and 5%, respectively. It is expected that the key rate in these countries will be increased in the coming months. At the same time, the key rate will not be raised in the USA. According to some experts, in the fall it can even be expected to decrease somewhat.
It is also worth understanding what a neutral percentage is. This term indicates the level of effectiveness of real interest in establishing dynamic economic growth while maintaining stable inflation. The answer to the question about the level at which it should be kept depends on the worldview of the person responsible. In recent decades, most central banks have set inflation targets within 2%. There are good reasons why many economists believe moderate inflation is better than zero. According to them, a moderate increase in prices stimulates economic processes and contributes to the growth of the economy. Some experts believe that in the current conditions, inflation expectations at the level of 2% are underestimated, since the climate crisis that the world is experiencing is causing both an energy and a food crisis.
It is more difficult to determine the level of neutral interest than the real one. It depends on many dynamically changing indicators. One way or another, now most countries are interested not in a neutral rate, but in a percentage rate. Countries with negative real interest rates – even as small as Israel’s – may soon find themselves needing to tighten their belts again.