The Un­wise War against Low In­ter­est Rates

Enterprise - - Con­tents -

Many in­flu­en­tial in­ter­ests and opin­ion-for­m­ers de­test to­day’s ul­tra-low in­ter­est rates. They are also clear who is to blame: cen­tral banks. Theresa May, UK prime min­is­ter, has joined the fray, ar­gu­ing that “while mon­e­tary pol­icy . . . pro­vided the nec­es­sary emer­gency medicine af­ter the fi­nan­cial crash, we have to ac­knowl­edge there have been some bad side ef­fects. Peo­ple with as­sets have got richer. Peo­ple without them have suf­fered. Peo­ple with mort­gages have found their debts cheaper. Peo­ple with sav­ings have found them­selves poorer. A change has got to come.”

So how might the gov­ern­ment de­liver such change? The an­swer is not ob­vi­ous. As Ben Broad­bent, deputy gover­nor of the Bank of Eng­land, notes, real long-term in­ter­est rates have fallen to zero (or be­low) over the past quar­ter of a cen­tury. Fur­ther­more, as the In­ter­na­tional Mon­e­tary Fund points out, core con­sumer price in­fla­tion has been per­sis­tently weak in high-in­come economies. Mr Broad­bent ar­gues: “With in­fla­tion rel­a­tively sta­ble in all these coun­tries, it’s hard to be­lieve cen­tral banks were do­ing much else than . . . fol­low­ing a sim­i­lar de­cline in the neu­tral rate of in­ter­est.”

At first glance, then, cen­tral banks are just fol­low­ing real eco­nomic forces while tak­ing ac­count, as they should, of re­cent de­mand weak­ness caused by the fi­nan­cial cri­sis and the ex­ces­sive build-up of pri­vate debt that pre­ceded it. An in­di­ca­tion of this de­mand weak­ness is the per­sis­tence of fi­nan­cial sur­pluses (ex­cesses of in­come over spend­ing) in the pri­vate sec­tors of high-in­come economies - no­tably in Ja­pan, Ger­many and the eu­ro­zone - de­spite ul­tra-low in­ter­est rates. This is why the Bank of Ja­pan and the Euro­pean Cen­tral Bank have re­mained par­tic­u­larly ag­gres­sive.

Given this back­ground - the sus­tained de­clines in real in­ter­est rates, chron­i­cally low in­fla­tion and fee­ble pri­vate de­mand - does a cred­i­ble al­ter­na­tive set of poli­cies ex­ist?

One kind of ob­jec­tion to present poli­cies is mainly a howl of pain: low in­ter­est rates un­der­mine the busi­ness mod­els of banks and in­sur­ance com­pa­nies, lower the in­comes of savers, dev­as­tate the sol­vency of pen­sion schemes, raise as­set prices and worsen in­equal­ity. As Mark Car­ney, gover­nor of the Bank of Eng­land, noted re­cently, mon­e­tary pol­icy has dis­tri­bu­tional con­se­quences but “it is for broader gov­ern­ment to off­set them if they so choose.” Whether the gov­ern­ment should use fis­cal re­sources to com­pen­sate peo­ple who hold large amounts in sav­ing ac­counts is doubt­ful. These are hardly the poor­est. More­over, to the ex­tent that low rates pro­mote re­cov­ery, al­most ev­ery­body ben­e­fits.

The dis­tri­bu­tional con­se­quences of post-cri­sis mon­e­tary poli­cies are also com­plex. In the UK the dis­tri­bu­tion of in­come seems to have be­come less un­equal, but the dis­tri­bu­tion of wealth more so, since the cri­sis. Lower in­ter­est rates need not worsen pen­sion deficits; that de­pends on what hap­pens to the value of as­sets held by pen­sion funds. Nor­mally, lower in­ter­est rates should raise the lat­ter. What would lower both real in­ter­est rates and as­set prices is greater pes­simism about eco­nomic prospects. Cen­tral banks do not cause such pes­simism but try to off­set it. Fi­nally, the im­pact of low rates, even neg­a­tive nom­i­nal rates, on the busi­ness mod­els of fi­nan­cial in­ter­me­di­aries can be dealt with only by chang­ing those mod­els or elim­i­nat­ing the need for such low rates al­to­gether.

A more co­gent set of ob­jec­tions is that the pol­icy frame­work or view of how mon­e­tary pol­icy works is mis­guided.

The heart of the frame­work is in­fla­tion tar­get­ing, which can in­deed cause prob­lems - no­tably if the im­pact of mon­e­tary pol­icy on fi­nance is ig­nored, as hap­pened be­fore the cri­sis. But it is im­pos­si­ble to be­lieve that de­fla­tion would make manag­ing a world econ­omy char­ac­terised by chron­i­cally weak de­mand any eas­ier. On the con­trary, de­fla­tion could make highly neg­a­tive nom­i­nal rates nec­es­sary. That would be prac­ti­cally and po­lit­i­cally dif­fi­cult. Not only

main­tain­ing the in­fla­tion tar­get, but achiev­ing it, is es­sen­tial.

Some even ar­gue that low rates weaken de­mand by low­er­ing spend­ing, stalling pro­duc­tiv­ity growth and stim­u­lat­ing pri­vate bor­row­ing. Yet there is no clear rea­son why low rates should lower ag­gre­gate spend­ing since they merely shift in­comes from cred­i­tors to debtors. Low rates also make bor­row­ing cheaper. That should stim­u­late in­vest­ment and so in­crease pro­duc­tiv­ity growth.

Low rates are in­deed in­tended to make debt more bear­able and en­cour­age bor­row­ing and spend­ing. If gov­ern­ments dis­like this mech­a­nism, they need to re­place pri­vate with pub­lic bor­row­ing, ideally in sup­port of in­vest­ment in in­fra­struc­ture. In ad­di­tion, they need struc­tural re­forms, no­tably in tax­a­tion, to en­cour­age pri­vate in­vest­ment and dis­cour­age sav­ing. Among big high-in­come coun­tries, Ger­many and Ja­pan most need such struc­tural re­forms.

What Mrs May has done so far is cause con­fu­sion. It is a mis­take for a head of gov­ern­ment to crit­i­cise a cen­tral bank in its ef­forts to achieve the tar­get the gov­ern­ment it­self has set. More­over, there is no good rea­son to be­lieve the BoE is go­ing about its man­date in the wrong way. If, how­ever, the gov­ern­ment wants to change that man­date, then this re­quires care­ful thought. All changes cre­ate big risks. Throw-away lines are sim­ply the wrong way to start this, par­tic­u­larly given Brexit. Fi­nally, if the gov­ern­ment wants to shield the losers from mon­e­tary pol­icy, it must weigh other claims on its scarce re­sources.

If, how­ever, it wants to lighten the load on mon­e­tary pol­icy, let us cry “Hal­lelu­jah.” It is past time that gov­ern­ments ex­am­ined the com­bi­na­tion of fis­cal pol­icy, debt re­struc­tur­ing and struc­tural re­forms that could help cen­tral banks de­liver the vig­or­ous eco­nomic growth the world econ­omy still needs.

In­done­sia’s cen­tral bank should cut its bench­mark in­ter­est rate by up to 100 ba­sis points, to 6.5 per­cent, by the end of this year, to help re­vive South­east Asia’s largest econ­omy, the coun­try’s vice pres­i­dent has said.

The cen­tral bank, which sur­prised mar­kets last month by cut­ting its bench­mark rate, kept its in­ter­est rate un­changed at 7.5 per­cent on Tues­day, say­ing the level was con­sis­tent with ef­forts to con­tain in­fla­tion and the cur­rent ac­count deficit.

“This year, 7 per­cent would be OK, or 6.5 would be OK too, be­cause you need more in­vest­ment when the econ­omy is slow,” Vice Pres­i­dent Jusuf Kalla said in an in­ter­view. “If your in­ter­est rate is higher, then they are more likely to save.”

Kalla said In­done­sia’s in­ter­est rate, the bench­mark for de­ter­min­ing the cen­tral bank’s de­posit and lend­ing fa­cil­ity rates, was much higher than other Asian coun­tries and must be low­ered grad­u­ally to as low 5 per­cent to bet­ter com­pete with its neigh­bours.

The vice pres­i­dent said he and Pres­i­dent Joko Wi­dodo had reg­u­larly met top cen­tral bank of­fi­cials over the past month, urg­ing them to cut in­ter­est rates as in­fla­tion drops.

A cut in in­ter­est rates of that mag­ni­tude would likely pres­sure the ru­piah, which is al­ready at a near 17-year low, and spark an out­flow of for­eign funds.

The cen­tral bank has to also fac­tor in the risk posed to In­done­sia, along with some other emerg­ing mar­kets, once the Fed­eral Re­serve de­cides to raise U. S. in­ter­est rates.

Asked whether In­done­sia should lower in­ter­est rates if it led to fur­ther weak­ness in the ru­piah, Kalla said: “Every­day we ex­plain that the ru­piah weak­en­ing is not be­cause of our econ­omy, but be­cause the Amer­i­can econ­omy is do­ing bet­ter and the U. S. dol­lar is strength­en­ing.”

In­done­sia needs for­eign in­vest­ment to help fund its cur­rent ac­count deficit. Kalla said the gov­ern­ment prefers long term for­eign in­vest­ment over port­fo­lio funds.

Pres­i­dent Wi­dodo, who took of­fice in Oc­to­ber, wants to spur eco­nomic growth from a five-year low of 5 per­cent to 5.7 per­cent this year.

The pub­lic lob­by­ing by In­done­sia’s top two elected of­fi­cials have raised ques­tions about the in­de­pen­dence of the cen­tral bank.

When asked about those con­cerns, Kalla replied, “In­de­pen­dent from what? Maybe in­de­pen­dent from the min­is­ter of fi­nance, but not in­de­pen­dent from the state.”

Bank In­done­sia spokesman Peter Ja­cobs de­clined to com­ment specif­i­cally on the vice pres­i­dent’s tar­get for the bench­mark in­ter­est rate, and in­stead noted the low level of an­other key rate.

“Other coun­tries’ pol­icy rate is the one di­rectly af­fect­ing the overnight money mar­ket, which in our case is the de­posit fa­cil­ity rate. It is al­ready quite low at 5.5 per­cent,” Ja­cobs said.

Bank In­done­sia Gover­nor Agus Mar­to­war­dojo has said that the gov­ern­ment has not in­ter­fered with cen­tral bank mon­e­tary pol­icy de­ci­sions.

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