Rational and essential , or misguided and dangerous ?

Friday 23rd September 2016

Rational and essential , or misguided and dangerous ? Whatever your view, ultra-low rates alone just won't do it .....

ref :- "The low-rate world", The Economist, Leader

For many of those of an older vintage, this world of super-low rates must seem a very different place to one in which they cut their teeth. And as for negative rates ..... well, that's plain weird. The very idea of getting charged for saving and paid for borrowing, whilst almost $10 trillion of rich-world government debt trades at negative yields, would have fallen squarely under the banner of "Not in my lifetime !".

Not only did it happen, but negative rates have been around for well over two years and there's a very fair chance that short-term rates in places like Japan may go more negative before they head the other way. In short, NIRPs (Negative Interest Rate Policies) aren't going away anytime soon, despite growing scepticism regarding ultra-low rate solutions and concern over the possible dangers they bring with them.

The front page and principal leader in this week's Economist examines how we got to where we are, the challenges past, present and future faced by the central banks and how the way forward is going to require a lot more than the monetary authorities can deliver on their own. It's well worth a read, particularly perhaps for those who like to bang on about perceived shortcomings in central bank actions (or lack of them) and forget too easily about their achievements in the recent past (who, me?).

We should all remember that central banks were praised during the financial crisis and in its immediate aftermath. As the Economist puts it, the bold decisions to slash rates and print money to buy bonds (QE) "stopped a shock from becoming a depression". Unfortunately for the central banks, the continuation of those policies no longer meets with universal acclaim.

Whether you agree with the criticism or not, it is perfectly legitimate to raise concerns about damage done in crucial areas of economies by super-low interest rate regimes. Fundamental problems include : the massive hole in pensions caused by the inability of funds to secure adequate return on investments ; the effect on banking systems when banks' profitability is undermined by flat yield curves (no mileage in borrowing short and lending long) and skinny margins ; and the inevitable asset-price inflation that accommodative policies bring which becomes increasingly vulnerable to sharp sell-offs.

What is less legitimate is the criticism aimed at central banks by politicians. German Finance Minister Wolfgang Schauble has said that the European Central Bank's negative rate policy has punished German savers, and therefore the ECB must take the blame for the swing to the right-wing Alternative for Germany party in recent elections. More startling was Donald Trump's accusation that Fed Chair Janet Yellen is keeping rates low to benefit the incumbent Democratic party. (Are we missing something ? How does he get away with saying things like that ?).

The Economist is nothing if not even-handed, pointing out that it's not all the central banks' doing  --  real interest rates have been on the decline for decades for reasons of demographics and China-led savings being introduced into the world economy. More to the point, there's an argument that would suggest that rather than being reckless, central banks haven't been bold enough (you see it's true ..... you really can't please everyone). But the thrust of the article centres on how the world has to do more, much more, than rely on monetary policy.

You've heard it before .... structural reforms and fiscal stimulus, but the Economist goes further. Structural reforms are important but by their very nature take an age to have an effect. There are issues too with  the kind of fiscal stimulus that is generally understood by the term .... infrastructure spending : roads, bridges, that kind of thing. For all the many benefits, this kind of spending does little in the short-term to boost weak demand and large capital projects are too cumbersome to fill the role of  fine-tuning the economy.

Politicians must take over some of the burden from central bankers but at the same time fiscal policy must not get bogged down in politics. Realistically, does that sound like a bit of a stretch ? Read this article for some ideas on how it should be done ..... it comes down to small-government Keynesianism which, it turns out,  is not a contradiction in terms after all. You'll also discover how to work the term "automaticity" into your text ....  should you ever want to, that is.