Expect to hear a chorus of grumbling from various parts of New Zealand on Thursday when the Reserve Bank is set to hike the Official Cash Rate (OCR) for the first time in almost four years.  

The move is not a foregone conclusion, but with the market "90 per cent" confident of a 25-basis point hike (plus all the throat clearing, nudging, and winking that has been coming from No 2 The Terrace over the past few months), a bump-up in the interest rate is pretty much guaranteed. 

These kinds of hikes are typically followed by rise in the currency and a rush by the banks to lift their lending rates. 

And although the quantum of these movements is debatable (depending on how much you think it is already priced in), you can be certain it will generate a lot of headlines. 

Manufacturers and exporters will bemoan the effect the announced hike has on an already elevated currency, and we are almost sure to see a concerned family on the front page of a daily newspaper wondering how they are going to afford their mortgage payments. 

These are all natural 'what about me' concerns but they ignore the flip side of the beneficiaries of higher interest rates - savers, and of cheaper imports - consumers.  

To weigh up the merits of a rate hike requires a broader assessment. It is useful to consider the counterfactual: what if the Reserve Bank didn't, or indeed couldn't, raise the OCR? 

Now before you dismiss this as an obtuse thought experiment that only economists in their ivory towers would ponder, consider that this is exactly the position the US Federal Reserve finds itself in.  

The Fed is tasked with three overarching functions, namely maximising employment, delivering moderate long-term interest rates and delivering price stability. 

As it stands, the US central bank's main tools to accomplish these functions are interest rates moves and an asset purchasing programme (better known as quantitative easing).  

Very simplistically it works like this: if the US employment rate drops to a concerning level, the Fed can lower interest rates to encourage borrowing and so stimulate the economy. It might do this by buying government bonds from private holders such as commercial banks, allowing them to increase their lending. 

Prices, wages and employment may be sustained by such means. 

This monetary stimulus might also stop asset prices, such as stocks or houses, from falling as much. (It works in reverse too, if the economy is overheating.) 

With extraordinary measures like quantitative easing, the US central bank buys large amounts of private securities instead of, or in addition to, government securities. 
  
If the buying is focused on a particular sector (e.g. housing mortgages), the initial effects may be greater on this sector than on others.  

In either case, long-term interest rates are lowered and commercial banks have greater reserves they can lend. It can be thought of as a way of taxing savers in order to encourage borrowing in the expectation of stimulating the economy. 

Only the US has painted itself into a corner. In 2000, the number of US people in, or looking for, work (excluding prisoners, minors and military personnel) started to fall as the economy entered a recession. 

The Fed's response was to cut interest rates aggressively from 6.25 per cent before September 2001 down to 0.5 per cent by 2004. 

Yet the employment rate did not respond, declining by over a percentage point to 66 per cent over the same period. 

Things don't always work out as predicted by mainstream theory.Interest rates for much of this time were effectively set at zero because inflation was running at about 2 percent. 

This, in conjunction with other factors, gave rise to the housing boom, where it was cheaper to borrow money than leave it in the bank, triggering the asset price bubble that would play a major role in the 2008 crash. 

After 2004, the US employment rate briefly stabilised in the pre-2008 Bull Run (when interest rates rose to over 6 percent again) but dropped sharply as the Global Financial Crisis struck. 

The Fed slashed the interest rate to 0.5 per cent, where it now sits, and implemented three rounds of quantitative easing, yet employment levels dropped further to 63 per cent from 66 per cent just before the crisis. 

The Fed is now trapped in a compromised position where any moves to trim the asset buying programme, or even a hint about lifting interest rates, sends shivers through the share market and sees business confidence drop, thereby threatening employment even further.  

And yet by keeping rates below zero in real terms, the US continues to borrow heavily. Company debt now stands equivalent to 80 per cent of GDP, about on par with pre-GFC levels, and more than twice that of where it stood in the mid-1960s. 

Clearly this represents a massive risk to the US economy, but the Fed's hands are effectively tied. 

In New Zealand, the Reserve Bank is arguably less compromised by a many-headed mandate than the Fed. 

Our central bank is intended to be more focused on price stability (a medium-term objective) than the more problematic task of removing business cycle risk from borrowers. It can move interest rates in direct response to the needs of the economy, as it did in 2011 when it slashed the OCR by 50 basis points in the wake of the Canterbury earthquakes.  

At a historic low of 2.5 per cent, these stimulatory interest rates have worked their course such that business confidence and terms of trade are pinging near record highs, and the pace of annual GDP growth is heading towards 3 per cent.  

But equally, it has also boosted appetite for debt. 

Household debt levels, measured as a percentage of nominal income, are back on the rise after the post-GFC deleveraging and now stand at just over 16 per cent. 

According to the Reserve Bank, total housing and consumer loan debt has increased six-fold in dollar terms since 1991, more than twice as much as GDP. 

It must also be recognised that easy access to money has stimulated our booming housing market (although supply constraints still account for the biggest spikes in prices).  

So should the Reserve Bank move on Thursday, this correspondent would urge you to look through the pain of borrowers and exporters alike, and see this hike, and the ones to follow, for what is: a sign of prudent fiscal management ... even if it hurts. 

Source: OCR hike prudent even if it hurts