No one likes to admit defeat. But global policymakers, who continue to insist that there’s more they can do to revive growth and inflation, are starting to sound like Monty Python’s Black Knight, the limbless and mortally wounded warrior who threatens to bleed on his victorious opponent. The truth is that governments and central banks have very few weapons left -- and have probably lost any chance they once had of averting a prolonged stagnation.
Clearly, the real economy hasn’t responded as hoped to zero and now negative interest rates. A whole host of factors continue to depress personal spending -- high debt, stagnant incomes, unemployment and underemployment, and economic uncertainty. Even the rich, who have benefited immensely from the run-up in asset prices, can’t really spend much more than they already are.
Slowing demand globally and overcapacity in many industries have in turn crimped investment. Despite the mountains of cheap money made available by central banks, lending hasn’t picked up. The velocity of money remains low.
Banks are hurting as low and negative rates damage their funding and their profits. Slashing rates even further would simply encourage depositors to transfer their savings elsewhere or convert them into cash, unless governments somehow banned such measures. Already negative rates are calling into question the ability of insurance companies and pension funds to meet contracted retirement payments.
Unconventional monetary policies are also undermining fundamental market mechanisms. Japan’s central bank now owns so many government bonds, corporate bonds and even stocks that it’s affecting financial markets. Indeed, the growing sway of central banks is reminiscent of the Soviet attempt, under Lenin, to assert government control of the “commanding heights” of the economy.
At the same time, the limits of these policies are becoming apparent to all. Japanese and European central banks are running out of suitable securities to buy. It’s not at all certain that further interest rate cuts or more quantitative easing would have much impact on market rates, asset prices or currency values.
That’s prompted a new consensus: Governments must pick up the slack using fiscal stimulus. Yet many developed economies are already running significant budget deficits and, in some cases, structural deficits. If additional government spending finances consumption, then it needs to be ongoing to remain effective. If it finances investment such as infrastructure, then the long-term effect depends on the project. Just because governments can borrow at artificially low or negative rates doesn’t mean their spending will produce high returns. The danger is that capital becomes tied up in poorly performing assets.
Moreover, the multiplier effect of new government spending has to be high enough to enable a self-sustaining, virtuous cycle of economic growth, thus increasing income and employment. Otherwise, even if the spending has social benefits, it’ll detract from prosperity, especially in the longer run.
By now, the credibility of policymakers is in doubt. Confused or contradictory communications, frequent changes of strategy and inaccurate forecasts have undermined confidence. Many of the supposedly “new” options being floated appear suspiciously like repackaged versions of previous, unsuccessful policies. Japan’s QQE (quantitative and qualitative expansion) combines QE and forward guidance. YCC (yield curve control) is not dissimilar to the Fed’s “twist,” targeting the shape of the yield curve to offset the deleterious effects of negative rates on financial institutions. Helicopter money (governments making payments to citizens) and universal basic income (a minimum guaranteed income) are essentially different names for government spending funded by the central bank, with a dash of permanence added.
Febrile markets have leaders in a bind. Any withdrawal or reduction of central bank support may result in substantial losses on existing investments and sharp falls in asset values. The recent volatility in bond rates, which caused losses of up to 15 percent on some long-dated securities, shows how a policy miscalculation could well trigger a major dislocation.
On the other hand, doubling down on extreme measures will only injure rather than restore confidence among the public. The kind of world that necessitates the government-sanctioned seizure of savings (through negative rates) and central banks creating money and dropping it on the population fuels uncertainty and fear for the future. Telling people that the economy is fundamentally sound is pointless; businesses and households naturally wonder why, if things are so good, such unconventional measures are required at all.
Policymakers lost their best chance to avoid this dilemma years ago, soon after the 2008 crash. Authorities then should have begun weaning themselves off a model reliant on debt-fueled consumption or investment; restructured unfunded and unsustainable future entitlements; addressed global imbalances by forcing currency realignments and implemented changes that would have subordinated Wall Street to Main Street again.
This would’ve led to a sharp contraction no doubt, and would have forced societies to address the question of how to cushion vulnerable elements of the population from hardship, raising the specter of redistributing wealth. But it would have laid the groundwork for a stronger and more sustainable recovery. By attempting to forestall the pain, leaders have only created a bigger headache for themselves.
By Satyajit Das
Satyajit Das is a former banker whose latest book is “A Banquet of Consequences.” –Ed.
Bloomberg
