Down in the Hole, time to stop digging
Picture of the week
his weekend in a little place called Jackson Hole, Wyoming, central bankers of the world are gathering for their annual contemplative retreat on the craft of monetarism and the state of the global economy. Deeply contemplative it may be, but it is too much to hope they will emerge from the Hole with a decision to stop digging.
For the best part of eight years since the global financial crisis they have been trying to produce sustainable growth with inflationary tools.
They took their base interest rates as low as they could and when that didn’t work, some took the rates below zero, effectively a charge for savings. When that didn’t work, they started increasing the quantity of money in their economies.
“Quantitative easing” hasn’t worked either.
Lowering the cost of money might have prevented the Global Financial Crisis turning into the Great Depression, and increasing the quantity of cash might have avoided a “double- dip” recession, but it has become a tonic for every crisis. ‘
When Europe was struggling with the euro its central bank promised to “do whatever it takes”. The morning after Brexit the governor of the Bank of England spoke resolutely from a rostrum resembling a papal window.
Flooding a crisis with cash may avoid the immediate consequences but it doesn’t restore an economy to robust health, and doesn’t cure the cause of the crisis. It makes it worse. Cheap loans in the United States, made worse by financial markets’ confidence the Fed would underwrite anything they did, created the subprime mortgage bubble that led to the GFC. Despite closer supervision of bank lending since then, house prices have been rising faster than before.
Meanwhile, the US economy takes fright every time the Fed tries to raise interest rates and the European Union and Japan are still flatlining on the life support of quantitative easing.
Reviewing the state of the world in a speech this week, New Zealand’s Reserve Bank Governor, Graeme Wheeler, said, “Global economic growth remains significantly below its long- term average despite unprece- dented monetary accommodation.” The volume of global merchandise trade had “drifted lower since the start of 2015” while “trade restrictions in G20 countries have been rising steadily and many governments are concerned about the strength of their exchange rates”.
Wheeler is not at Jackson Hole this weekend, having sent Deputy Governor Grant Spencer in his place, but in that speech he listed the questions central banks are grappling with. One of them was: “Has monetary policy reached the limits of its effectiveness in central banks with negative policy rates and large programmes of quantitative easing?”
New Zealand and Australia, fortunately, have not touched these drugs. But we are suffering from the damage they are doing in house prices. Last week, for the second month in succession, the Reserve Bank lowered its base interest rate despite continuing strong growth, low inflation and rampant property prices. All these, especially the last, argued for a rise in interest rates but Wheeler has to avoid getting out of step with interest rates in other countries because that would push the dollar higher and hurt exporters.
Something interesting is happening here, though.
Last month, and again last week, our trading banks have been reluctant to pass on the full cut to the official cash rate in their mortgage lending rates.
It is as though the trading bankers have taken over the task of managing our monetary settings, aware that the Reserve Bank is obliged by conventional practice and its inflation target to follow this pointless international stimulus.
It is pointless because people know it is artificial. Monetary stimulants have not worked for the same reason Keynesian fiscal stimulants failed to work in the 1970s, and arguably didn’t work in the 1930s either. If the GFC was 1929 we are now in 1937, when there was still fear of slipping back into recession and democracies were susceptible to bullies and demagogues who cast themselves as personally and uniquely strong by demonising minorities.
The stimulants don’t generate sustained growth because business and personal investors are rational. They have not responded to low interest rates by investing in production and expansion, they have put their money into buying, or buying back, shares or into real estate. Rationally, they know monetary and fiscal life supports have to be withdrawn sooner or later, and at some point central banks will need to start containing the inflation triggered by their excess money supply.
Since its adoption in the 1980s, monetarism has proven successful at combating inflation in growing economies, but recent experience has shown it is not capable of rekindling growth. Bankers might do better to take economies off the drip, turn their full attention to house prices, raise interest rates and convince business and investors they are about to see reality return.
If the GFC was 1929 we are now in 1937, when there was still fear of slipping back into recession and democracies were susceptible to bullies and demagogues who cast themselves as personally and uniquely strong by demonising minorities.