Monetary policy may have reached its limits in giving a lift to depressed economies. Might building more bridges work? Simon Wilson reports.
What’s the background?
Since the financial crisis of 2008 economies have been hit by a succession of crises and panics, including the eurozone’s sovereign debt crisis and frequent jitters over Chinese growth. Each time, as Antoine Gara puts it in Forbes, investors have been rescued by central banks, who have “opened up an unprecedented spigot of cash to avert a double-dip recession, causing bond yields to hit record lows and stocks to breach new record highs”.
Ultra-low interest rates and ample liquidity may have averted a depression, but the recovery has been historically lacklustre. And there’s a growing sense – both from central bankers and from politicians – that the recent era of ultra-loose money may be nearing its end.
Government spending: why stop printing money?
Because it may be doing more harm than good. In the UK, where public criticism of the Bank of England is rare, Theresa May told the Conservative party conference that quantitative easing had contributed to a rise in inequality. William Hague demanded the Bank raise rates or its “much-vaunted independence will come, possibly quite dramatically, to its end”. In the eurozone there’s been strong German opposition to the European Central Bank’s (ECB) programme of bond-buying and negative interest rates.
“The disappearance of interest is creating a gaping hole in citizens’ retirement provisions,” one minister said earlier this year. Finance minister Wolfgang Schäuble even claimed the surge in support for the rightwing populist Alternative für Deutschland party was due to the ECB’s policies.
Are they right?
There are clearly adverse side-effects of ultra-loose monetary policy. It hits retirement savings, creates economic distortions, and has compounded wealth inequality by pushing up asset prices, including housing and stocks. Even so, the threat to central banks’ independence has been over-egged, argues Michael Pearce of Capital Economics in a research note published this week. He predicts that loose monetary policy will continue, alongside more expansionary fiscal policies.
Indeed, in some economies there has “already been a blurring of lines between fiscal and monetary policies”, argues Pearce. For example, the Bank of Japan’s decision to set a yield target of 0% for ten-year bonds affects fiscal policy as much as monetary policy because it fixes the government’s nominal borrowing costs. And in the eurozone, the ECB rules governing which bonds it includes in its asset-purchase programme affect fiscal policy in the peripheral economies (Spain and Portugal have both loosened fiscal policy this year).
Is it time for greater fiscal stimulus?
Some influential policymakers clearly think so, not least the chair of the US Federal Reserve, Janet Yellen. “Fiscal policy has traditionally played an important role in dealing with severe economic downturns”, said Yellen recently, noting that fiscal policy could “help take some burden off of monetary policy”. It may well be that she gets her wish next year. Both Hillary Clinton and Donald Trump have promised to boost spending on infrastructure. The IMF, too, has urged governments to “take advantage of low rates” to borrow and spend on infrastructure and the like.
Does fiscal stimulus work?
That’s one of the great central arguments of modern economics. The Keynesian consensus that dominated post-war thinking was that during slumps fiscal stimulus by governments doesn’t crowd out private activity because the economy is operating below capacity. Instead, government spending ripples across the economy, boosting the incomes of those working for firms who receive government contracts, or those on benefits, who then go on to spend and invest more, in a virtuous circle that helps the economy recover.
So-called New Keynesians (who include most of the major policymakers of the last few decades) have typically held that monetary policy is a more effective tool than fiscal policy. However, post-crisis Keynes has made a comeback once more, says The Economist. “Plenty of economists now argue that insufficient fiscal stimulus has been among the biggest failures of the post-crisis era.”
What’s the opposing view?
Some analysts argue that major doses of fiscal stimulus are self-limiting and self-defeating. For example, Deutsche Bank’s chief strategist Binky Chadha argued in a research note this month that the 23% increase in US government spending just after the financial crisis “simply front-loaded five years of growth in dollar outlays”. As government spending fell back towards trend after the stimulus, it acted as a drag on growth – a drag that endures seven years into the recovery.
A similarly sceptical view is taken by Steven Ricchiuto of Mizuho Securities, who predicts that “increased deficit-financed fiscal stimulus will lead to a couple of quarters of increased growth before rising real yields [due to investors rushing to bet on higher growth and inflation] and a [consequent] currency appreciation create an offsetting drag pulling the growth back towards a 1.5% to 2% trajectory”.
What is Britain planning?
According to sources cited by the FT, Philip Hammond told cabinet colleagues on Tuesday to expect only a modest fiscal stimulus in his Autumn Statement (due on 23 November), with a programme of new infrastructure spending expected to run to the low billions of pounds a year.
But his new, more “flexible” fiscal plan, while aimed at achieving a balanced budget in the next parliament, would also allow a greater stimulus package to be unleashed if the current reasonably robust rate of economic growth starts to falter. “The goal is to create some headroom so it can be deployed if necessary,” said an official source cited by the paper. “The chancellor made it clear we face an unprecedented level of uncertainty.”