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.
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