In Haldane’s view the current conjuncture is rather different to that which prevailed in the wake of the GFC when the recovery was a rather slow and protracted affair. This supported the slow withdrawal of the post-2008 stimulus but with the economy apparently set to grow very strongly in 2021 “this time that policy script feels stretched.” The danger is that large and rapid balance sheet expansions (chart) but limited and slow withdrawals “puts a ratchet into central bank balance sheets” which raises concerns of fiscal dominance – the extent to which monetary policy becomes subservient to the needs of the fiscal authorities to manage deficits and debt rather than the primary goal of fighting inflation. Economists agree that large volumes of asset purchases do increase the risk of fiscal dominance but are less in agreement that recent actions will lead to such an outcome. There have been suggestions, particularly in Germany, that the ECB’s policies in recent years have been designed to support the heavily-indebted euro zone economies although we will only know if fiscal dominance has taken root if the ECB fails to act in the face of any inflation pressure. But as Haldane put it, “this is the most dangerous moment inflation-targeting has so far faced.”
He also pointed out that “a dependency culture around cheap money has emerged over the past decade.” I have a lot of sympathy with this view and argued strongly that central banks should have been quicker off the mark from 2013 onwards to withdraw some of the monetary stimulus put in place after the GFC. This is not to say that policy should have turned restrictive but it perhaps should have been less expansionary. After all, as I have consistently pointed out, the economy in 2012/13 may not have been in great shape but it was in far better condition than in 2008/09. The actions of central banks in the five years after the GFC were akin to performing life-saving surgery on a patient long after they had left the operating theatre and were resting on the ward.
As with all procedures there are side effects and one of those associated with lax monetary policy is extremely high asset values, both financial (equities) and real (housing). If investors do not expect central banks to take some air out of the balloon, they will continue inflating prices. This is more than just a financial market problem – there are social implications as well. For example, many young people who were leaving school in 2008 will now be thinking of starting families but find themselves priced out of the housing market. Moreover, rising asset values are fine for those sitting on a portfolio of stocks but serves to enhance the wealth disparity versus those who do not. And as I have been pointing out for some time, low interest rates penalise savers – particularly those nearing retirement. Expansionary monetary policy is undoubtedly the right policy in the right conditions but I am with Andy Haldane in hoping that central banks do not wait too long before cutting back on some of the support they are currently providing.
Haldane’s speech stood in contrast to the BoE Governor’s annual Mansion House Speech, given a day later, which was a rather more conservative take on the state of the economy. That said Andrew Bailey did highlight the upside risks to inflation, and I agree with him that they are likely “to be a temporary feature of the bounce-back.” Bailey’s speech carried the usual warning from policymakers that the central bank is prepared to tighten monetary policy if required to stave off an inflation threat but that this does not form part of the current baseline. Whilst inflation has not proven to be a problem in the wake of the GFC, so that this threat has never been put to the test, there may come a point where the BoE may have to follow up on its threat to take away the punchbowl.
There are some former BoE policymakers (notably Danny Blanchflower) who are completely opposed to the idea of raising interest rates any time soon, and who give no credence to the Haldane view of the world. But this is to assume that the conditions prevailing today are similar to those more than a decade ago. But this is not the case: As Bailey pointed out in his speech the degree of economic scarring following the recent output collapse has been far smaller than expected. Moreover, governments are adopting a much more active fiscal policy approach today, in contrast to a decade ago when monetary policy had to do all the heavy lifting.
A final argument as to why the zero (or negative) interest rate policy should have a limited shelf life is derived from the Japanese experience where more than 20 years of expansionary policy have done little to get the economy back on the path which the government desires. There is a general belief that monetary policy is neutral in the long-run i.e. it may impact on nominal quantities but does little to influence real growth rates or productivity. This has been borne out by the Japanese experience which demonstrates that monetary policy does nothing to impact on the supply side of the economy. This is hardly surprising: Monetary policy cannot boost the capital stock or improve education and training standards, implying that other policy prescriptions are required. The UK’s dire productivity performance over the past decade makes it clear just how much these alternatives are sorely needed.
As Andy Haldane goes off to face new challenges as Chief Executive of the Royal Society of Arts he will leave a gap at the BoE which will not easily be filled. He has not met with universal acclaim from within the economics profession but I have always found his willingness to cross-pollinate economic ideas with those from other disciplines has resulted in some illuminating insights. He will leave big shoes to fill.
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