Economists sometimes use complex words to describe fairly simple phenomena. “Trade-off” is a good example. A trade-off is nothing more than a dilemma. Or, more colloquially, a "short blanket"; if I want more of something, I have to be willing to give up a little on the other side.

The traditional dilemma between growth and inflation is often a typical trade-off in economics. If I want to lower inflation, I may have to sacrifice some economic growth. The way to manage this delicate growth-inflation balance is usually through the interest rate regulated by central banks.

That is precisely why, when the world began to gasp at the highest levels of inflation for 40 years in most regions as a result of the pandemic and then the war in Ukraine, central banks rushed to raise interest rates.

Thus, in just over 15 months, the Federal Reserve (the US central bank) raised rates from 0.25% to 5.25%, and the European Central Bank from 0% to 4.25%. In fact, 2023 marked a record as the year in which the highest proportion of central banks around the world raised interest rates (8 out of 10).

The global rate hike eventually managed to bring inflation back to acceptable levels. The price increase, which reached levels of between 8% and 10% annually in many countries during 2022, is now approaching the 2% target in the United States and the eurozone.

However, perhaps the most curious thing about this period of monetary tightening was that inflation fell without significantly affecting growth or causing a surge in unemployment. Economists call this a "soft landing," though we should remember that this is not the norm. In 6 out of 10 cycles, the rate hike has caused some recession in different regions. Achieving the right dose of contractionary monetary policy (rate hikes) without affecting the level of activity is not an easy task.

Why has global economic growth remained resilient? There is no simple answer, and the causes are multiple. They range from the restoration of normality in global value chains after the pandemic and the war, to the delayed effects of fiscal stimuli granted by governments during the pandemic, among others. But one aspect stands out: the resilience of job markets and resistance to rising unemployment rates in most economies. For example, despite the rate hike cycle, 2 out of 3 economies in which Santander operates are at or near full employment.

In a landscape where economic growth is sustained and inflation gradually returns to targets, central banks have begun the cycle of rate cuts in recent months. The speed of these cuts varies by region, depending on the robustness of economic growth and the resistance of inflation to decline. But the direction is clear.

However, the process will not be linear globally. There will be moments of pause in the cuts, including the need to temporarily raise them in some countries (as is happening in Brazil and others) to ensure the decline in inflation. The election of Donald Trump as President of the United States also raises questions about the pace of rate cuts, considering that some of the policies he could implement have an inflationary bias (rising tariffs on foreign trade, fiscal expansion, migration restrictions, etc).

But in the medium and long term, a world of lower rates will mean greater growth momentum. And particularly greater access to credit and greater incentives for investment. This aspect is key, especially when the world will face challenges in the coming years that require a huge amount of financing. One of them is the green transition, which is crucial for everyone's future. To achieve the imposed climate change goals, it is estimated that by 2050 approximately $275 trillion will need to be invested in physical assets.

What is clear is that, though the direction set by central banks with interest rates is downward, their end point will not be as low as the ultra-low levels seen before the pandemic (in the eurozone they were even negative).

There is a certain consensus among economists that the so-called "neutral interest rate" (which cannot be explicitly observed in any market but is theoretically estimated through various methods), has risen as a result of several factors ranging from demographic changes (aging population and pressure on pension systems) to the expected higher productivity resulting from the proliferation of generative artificial intelligence, through greater geopolitical fragmentation and the need for increased investments to address climate change

After all, the world requires appropriate interest rates so that financial systems and markets can effectively channel savings towards investment, which is the key to sustainable medium- and long-term growth.