The ECB meets tomorrow for its monthly monetary policy meeting, and next week central bankers in the US, Norway, Sweden and the UK will also discuss what to do about interest rates. “The question you have to ask is how they did it,” said economist Edin Mujagic.

One of the things central bankers worry about when setting new interest rates is output limits, Mujagic explained. ‘They have to estimate how big the difference is between current economic growth and the growth the economy can sustainably produce and how big that difference will be in a year or two.’

Estimation

And according to the economist, this is not an easy thing. “We already have great difficulty knowing what the economy is doing in any given quarter now, let alone what constitutes sustainable growth.” According to him, the percentage of output limits can only be estimated. ‘And this also changes over time, not least because of the decisions taken by these central bankers.’

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After estimating whether the economy is growing too fast or too slow, it must be determined what to do with interest rates. “You put the interest rate you want to set next to the neutral interest rate, which is the interest rate that the economy needs to grow well with stable inflation,” Mujagic said. But neutral interest rates must also be estimated, and these estimates vary. ‘And interest rates also change over time, partly because of central bank policy.’

Not a great track record

Banks don’t have good banks track record when making these kinds of predictions, however, this is not surprising given the complexity, Mujagic said. “You almost feel sorry for them.” However, according to the economist, this is of course unnecessary, with central banks making things even more difficult for themselves by dealing with ‘this incredible amount of predictions and estimates’. “They are the group of people who are responsible for how much money we print, and ultimately they are the ones who are the engine that influences the economy.”

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According to Mujagic, the Fed will ‘in all its wisdom’ decide next week to stop raising interest rates for the time being. The ECB has a more difficult task tomorrow, as inflation in the Eurozone remains high while the economy is not doing well. ‘In relation to inflation, interest rates should rise, but not in relation to the economy. However, with all due respect, the ECB has maneuvered in this regard.’