US President Franklin D. Roosevelt on a dime coin
The Global Money Addiction (interest rate dilemmas in context)
“Faced by failure of credit, they have proposed only the lending of more money”, Franklin Delano Roosevelt in his inaugural address, 4 March 1933
Debate around UK monetary policy recognises all is far from normal through the idea that when rate rises finally come, they will be limited in extent. But it is not clear that this captures the full uncertainty surrounding policy action on a domestic and global basis. As the great majority of the members of the Monetary Policy Committee seem to recognise, this uncertainty means that the risks associated with interest rate rises are still unacceptably high. Arguably, the same dilemmas also expose shortcomings in theoretical understanding and the policy framework that are still far from resolved.
Since the worst of the financial and economic crisis was halted, the global policy stance has been set to an extreme (and contradictory) mix of fiscal contraction and monetary expansion. The combined effect of these policies has been to restrain the pace and level of economic activity. This restraint as well as periodic failures of confidence in financial markets (sometimes related to certain individual economics, and not always the same ones) has meant an ever-increasing demand for monetary stimulus, primarily in the form of ‘quantitative easing’. [QE is the shorthand for the central bank creating money / expanding its balance sheet in order to buy up specified financial instruments from financial institutions – in the UK government bonds, but other central banks accept a much wider range of instruments.]
The UK policy debate comes in the wake of a huge shift in the policy centre of gravity from the US Federal Reserve to the European Central Bank (ECB). In the wake of fears for the global economy, from the end of 2012 to the end of 2014 the Federal Reserve pumped an additional $1.5tn into the US economy. On such a vast scale, some labelled the operation ‘QE infinity’. After faltering for only a few quarters, from mid-2013 GDP growth reverted to approaching 1 per cent a quarter. From the start of 2014 the US began to ‘taper’ QE– i.e. steadily reduce the extent of stimulus (the slope of the line shrinks). In October 2014 the tapering finished, and the QE programme was ended. Since then US GDP quarterly growth has again faltered considerably, even given the 0.6 per cent rise in Q2.
GDP quarterly growth and central bank balance sheets
(Note that the two charts are on the same scales; strictly they show the size of the balance sheet in cash terms, which doesn’t correspond always to the amount of QE; there is no Q2 figure for EZ GDP yet.)
The charts omit the first major expansions of central bank balance sheets over the most severe parts of the financial crisis in 2008-09. The second round of QE in the US kicked off at the end of 2010, again as recovery faltered (and the initial post-crisis fiscal stimulus was withdrawn), again effecting quick revival.
In the eurozone, economic crisis resumed in 2011. The European Central Bank (ECB) responded by expanding its balance sheet. Strictly they do not like to call this QE, because the expansion was for ‘refinancing operations’ with eurozone banks rather than to take up government debt and other assets. The actions were also temporary in nature (the balance sheet shrank back down), and moreover did not prevent a decline in GDP. Markets may have been re-assured when Mario Draghi (the head of the ECB) famously promised to do “whatever it takes” in July 2012, but it was still almost a year until some (very limp) kind of growth was restored – by which time US QE had meant the world was moving forwards.
But now it really is the ECB’s turn. In January this year, Draghi announced a QE programme amounting to around €1.1 trillion, €60bn a month from then until September 2016. While the scale of this operation was portrayed as a surprise, it is not dissimilar to QE infinity. ECB QE will expand the balance sheet by around 50 per cent from €2 to €3 trillion (likely taking around 7 quarters). The Federal Reserve balance sheet was also expanded by 50 per cent from $3 to $4.5 trillion (taking 8 quarters).
Both operations are enormous. $1.5 trillion corresponded to 9.4 per cent of US GDP of $16tn in 2012. Between the end of 2012 and the end of 2014, US GDP increased by $1.4 trillion in cash terms, just less than the money injected (though of course the money was injected into financial markets and there is not an obvious direct read-across to the economy). €1.1 trillion corresponds to 11 per cent of eurozone GDP of €10.1 trillion in 2014.
These exceptional initiatives are a reminder of how very far the global economy is from a normal condition. The government spending cuts that have been the norm across much of the world since 2010 have been set against a colossal monetary expansion. Indeed the monetary expansion has surely been found repeatedly necessary to contain the heavy downward pressures from fiscal policy. In the meantime, as many have pointed out, monetary expansion has served also to inflate global asset markets, including commercial and residential property as well as equity and bond markets. But while asset markets inflate, the overall lacklustre recovery and associated increases in the (potentially vast) scale of idle resources and weakness in particular of wages, has meant that retail prices are moving in the opposite direction, with deflationary pressures intensifying. On top of it all, the huge private debts (household and corporate, including financial firms) that built up ahead of the crisis have not gone away; as McKinsey recently recently put it:
Seven years after the bursting of a global credit bubble resulted in the worst financial crisis since the Great Depression, debt continues to grow. In fact, rather than reducing indebtedness, or deleveraging, all major economies today have higher levels of borrowing relative to GDP than they did in 2007.
The transition from the Fed to the ECB comes too at a particularly fraught moment, with the OECD pointing out that globally Q1 was the weakest quarter since the financial crisis, concerns about collapsing markets in China, weakness in other emerging markets (e.g. Brazil) and the Greek crisis.
In this context the Bank of England yesterday put paid to (and badly wrong-footed) economist commentary in the media that rate rises were increasingly imminent. The various material issued emphasised additional downward pressures on inflation (through falling commodity prices and the growing strength of sterling), uncertainties about the strength of GDP and a material weakening of labour market growth.
But more generally the UK ‘recovery’ originates also in the wider global monetary stimulus, as well as supplementary domestic measures. On top of the ongoing ultra-low Bank of England interest rate of ½ per cent, since the middle of 2012 there have been the ‘forward guidance’ framework for monetary policy, and the ‘funding for lending’ and ‘help to buy schemes’ that have amounted to major subsidies to banks for mortgage lending. These schemes in particular have effected reductions in mortgage interest rates, though it should be emphasised that the ultra-low official rate has not read across to low rates for many other types of household and corporate borrowing (the amount of mortgage lending has also been partially restricted following Bank of England concerns). Finally, there was also the coalition government’s relaxation of spending cuts: government spending growth of 2.5 per cent in 2014 was the highest since 2009.
But plainly and justly the extent of stimulus sits uncomfortably with monetary policymakers. Occasional commentary from the Bank for International Settlements might be regarded as giving voice to these concerns:
Debt burdens are still high, and often growing, relative to output and incomes. The economies hit by a balance sheet recession are still struggling to return to healthy expansion. In several others, financial imbalances show signs of building up, in the form of strong credit and asset price increases, despite the absence of inflationary pressures. Monetary policy has taken on far too much of the burden of boosting output. And in the meantime, productivity growth has continued to decline. (85th BIS annual report, p. 7)
The MPC minutes yesterday were striking too for comments about the balance between fiscal and monetary policy in the UK:
The difference in the future path of policy rates in the two countries [UK and US] expected by financial market participants might be because of a perception that the headwinds to demand would ease more rapidly in the United States than in the United Kingdom, which was in the process of a more significant fiscal consolidation, had stronger trade and financial linkages to the euro area, and where levels of household indebtedness were higher.
No matter how undesirable some economic symptoms may be, the (global) evidence of the post-crisis period is that the reaction to a removal of monetary stimulus can be far sharper than under normal conditions, and therefore means an unacceptable level of risk to the economy and labour market.
But this is not an argument for the indefinite preservation of the status quo. Instead it is a plea to confront more squarely the potential extent of the underlying fragilities, questions about the ongoing relevance of the underlying economic framework through (narrowly interpreted) output gaps and inflation targets, and the inadequacy and wrongheadedness of the present policy approach.
Under Roosevelt, whose complaint heads this piece, policy was more far reaching. He put heavy restrictions on the financial sector through in his two Banking Acts (1933 and 1935), abandoned the orthodox gold standard framework and set interest rates low (though not ½ per cent) on a permanent basis, and expanded government spending to a significant extent under his New Deal. He found an alternative to ‘only the lending of more money’, and one that was very successful.