The Kansas City Fed’s Jackson Hole Symposium is closely
scrutinised by market watchers for any indications of changes in the Fed’s
policy stance, and sure enough, most of the headlines over the weekend focused on Janet Yellen’s
comment that “the case for an increase in
the federal funds rate has strengthened”. But this is to overlook a lot of
other interesting material which comes out during the course of the two day
session. This year’s symposium was entitled “Designing Resilient Monetary
Policy Frameworks for the Future” and if there was any takeaway, it is that
central bankers believe they still have sufficient ammunition to provide cover
for the economic recovery. It was also evident that central bankers are aware
of the impact of low interest rates on the structure of the global monetary
system, and that we are not going back to a pre-2007 world anytime soon.
Marvin Goodfriend’s paper was interesting and makes the point that we should ignore the zero bound constraint on interest rates altogether, primarily because “the effectiveness of evermore quantitative monetary stimulus is questionable.” He argues that one way to facilitate an end to the lower bound constraint would be to abolish paper money and replace it with electronic money. This is not a new idea, having been kicked around since the 1930s and gaining currency (if you’ll pardon the pun) in the wake of the financial crisis. Indeed, Goodfriend’s policy prescriptions echo those made by Andy Haldane a year ago. In brief, this policy relies on central banks making it unattractive to hold cash, thus raising the incentive to hold it in an electronic account overseen by the central bank. The downside, of course, is that this reduces the control which individuals have over their own cash balances: you no longer have the choice of the bank or the mattress – it’s the central bank or nothing, which may persuade many to shift into assets such as property or gold, thus creating bubbles elsewhere.
A bigger objection to removing the lower bound on interest rates is that it has a massive distortionary impact on expectations. Will investors be willing to fund projects if the rate of return is zero or negative? Will we be prepared to continue handing over 30-40% of our earnings in tax (more in continental Europe) when we simultaneously have to invest to provide a fund for our retirement? How does the banking sector cope in a world of increasingly negative rates? Will we eventually reach a situation where customers are charged for depositing funds (actually, yes, with corporate clients in some countries already facing this problem)? For all these reasons and more, it should be evident that a prolonged period of zero or negative interest rates may lead to consequences which we cannot yet foresee and could cause major long-term economic disruption. It is one thing to try the policy on a temporary basis but when it becomes the norm, something is wrong.
Whilst I agree with Goodfriend’s point that QE is at the limit, the notion that we should abolish the lower bound should be treated as an interesting thought experiment and nothing more. The idea that central banks can continue to operate an ever looser monetary policy, but still fail to achieve their economic objectives, should act as an indication that there are deeper seated economic problems which require alternative solutions. Indeed, former Fed governor Kroszner argues that “many central banks are being asked to do things they simply can’t do. Central banks can try to fight deflation. Central banks can’t simply create growth.” Indeed, the ECB has made the point since its inception in 1999 that it cannot create the conditions for a sustainable pickup in growth on its own. Governments need to play their part with structural policies designed to raise the economy’s speed limit.
A bigger problem is that in the wake of the financial crisis, many European economies have been trying to accelerate with the brakes on. In other words, they have operated a very loose monetary policy and a tight fiscal stance. This reflects a misunderstanding about the nature of the shock which hit in 2008. Whilst this may have been understandable in the immediate wake of the crisis, we have had long enough to review the evidence to realise that the current policy mix is not delivering. It is clearly not creating stable jobs in sufficient quantities to allow economies to generate escape velocity, and as a result lots of people are taking out their frustration by voting for populist politicians. This is not the whole story: it certainly does not explain the rise of Donald Trump, but it is part of a wider narrative. We have already seen in the UK how this has panned out, but it is still not too late for other European countries to learn from this mistake. Failure to do so will have major adverse consequences for the euro zone in the years to come.
Marvin Goodfriend’s paper was interesting and makes the point that we should ignore the zero bound constraint on interest rates altogether, primarily because “the effectiveness of evermore quantitative monetary stimulus is questionable.” He argues that one way to facilitate an end to the lower bound constraint would be to abolish paper money and replace it with electronic money. This is not a new idea, having been kicked around since the 1930s and gaining currency (if you’ll pardon the pun) in the wake of the financial crisis. Indeed, Goodfriend’s policy prescriptions echo those made by Andy Haldane a year ago. In brief, this policy relies on central banks making it unattractive to hold cash, thus raising the incentive to hold it in an electronic account overseen by the central bank. The downside, of course, is that this reduces the control which individuals have over their own cash balances: you no longer have the choice of the bank or the mattress – it’s the central bank or nothing, which may persuade many to shift into assets such as property or gold, thus creating bubbles elsewhere.
A bigger objection to removing the lower bound on interest rates is that it has a massive distortionary impact on expectations. Will investors be willing to fund projects if the rate of return is zero or negative? Will we be prepared to continue handing over 30-40% of our earnings in tax (more in continental Europe) when we simultaneously have to invest to provide a fund for our retirement? How does the banking sector cope in a world of increasingly negative rates? Will we eventually reach a situation where customers are charged for depositing funds (actually, yes, with corporate clients in some countries already facing this problem)? For all these reasons and more, it should be evident that a prolonged period of zero or negative interest rates may lead to consequences which we cannot yet foresee and could cause major long-term economic disruption. It is one thing to try the policy on a temporary basis but when it becomes the norm, something is wrong.
Whilst I agree with Goodfriend’s point that QE is at the limit, the notion that we should abolish the lower bound should be treated as an interesting thought experiment and nothing more. The idea that central banks can continue to operate an ever looser monetary policy, but still fail to achieve their economic objectives, should act as an indication that there are deeper seated economic problems which require alternative solutions. Indeed, former Fed governor Kroszner argues that “many central banks are being asked to do things they simply can’t do. Central banks can try to fight deflation. Central banks can’t simply create growth.” Indeed, the ECB has made the point since its inception in 1999 that it cannot create the conditions for a sustainable pickup in growth on its own. Governments need to play their part with structural policies designed to raise the economy’s speed limit.
A bigger problem is that in the wake of the financial crisis, many European economies have been trying to accelerate with the brakes on. In other words, they have operated a very loose monetary policy and a tight fiscal stance. This reflects a misunderstanding about the nature of the shock which hit in 2008. Whilst this may have been understandable in the immediate wake of the crisis, we have had long enough to review the evidence to realise that the current policy mix is not delivering. It is clearly not creating stable jobs in sufficient quantities to allow economies to generate escape velocity, and as a result lots of people are taking out their frustration by voting for populist politicians. This is not the whole story: it certainly does not explain the rise of Donald Trump, but it is part of a wider narrative. We have already seen in the UK how this has panned out, but it is still not too late for other European countries to learn from this mistake. Failure to do so will have major adverse consequences for the euro zone in the years to come.
No comments:
Post a Comment