As the world’s central bankers gather at Jackson Hole on Thursday night, one economic phenomenon will hover over their deliberations more than any other. That is the large and growing share of loans around the world that bear a negative nominal interest rate: creditors paying their debtors to borrow.
Duncan Weldon has compared this phenomenon to John Maynard Keynes’s “euthanasia of the rentier”. Keynes envisaged that public and private investment in an economy kept at full employment investment would saturate it with capital and thereby erode the marginal return to be gained on private savings. Our current predicament, Weldon notes, is different: low rates are, if anything, the result of too little willingness to invest relative to the desire to save. As a result, “across much of Europe the rentier is being gradually euthanised whilst workers continue to suffer from weak real income growth and high unemployment”.
Weldon attributes this squarely to the wrong mix of fiscal and monetary policy. Because governments are trying too hard to rein in budget deficits, monetary policy has had to compensate with all the more stimulus. The resulting fiscal-monetary policy mix is as the textbook would predict: a recovery marked by very low borrowing costs and a retrenchment in government finances.
There is certainly a lot of truth in this story. Fiscal retrenchment across virtually the entire developed world has no doubt meant more monetary stimulus is required than would otherwise be the case to keep existing labour and capital employed. The timid, even counterproductive, fiscal policy stance of many countries bears a lot of blame for the slow recovery. For example, the chart below, borrowed from a new report by Josh Bivens, shows just how sluggish US government spending has been compared with earlier recoveries.
But is it also the main cause of low interest rates? Weldon seems to take this as a given, concentrating instead on the political economy puzzle of why such a policy was pursued if it is detrimental to the interest of electorally dominant pensioners. Paul Krugman picks up the baton to offer explanations.
It’s an interesting discussion, but it’s also a bit of a rabbit hole if the premise of the puzzle is wrong. And it is problematic to pin ultra-low interest rates largely on an inappropriate fiscal-monetary policy mix.
First, because it assumes that if fiscal policy was more expansive, monetary policy would be less so, so that central banks would tighten interest rates. But that presupposes two things: that economies are currently operating at their full potential (in which case bigger public deficits would crowd out private spending) so that it would be appropriate for central banks to raise rates; and second, that monetary policy is still in fact effective — that is to say, that more or less monetary action does indeed move market interest rates. The former is dubious to say the least. The latter is disputed by those who believe we are in a liquidity trap or at a lower bound for monetary policy.
As Free Lunch readers know, this column rejects this monetary nihilism: central bank policy remains effective. Does that mean more fiscal stimulus would indeed allow higher rates? Hardly. First, because regardless of the fiscal-monetary mix, the overall demand stimulus is too weak. Neither fiscal policy nor monetary policy is doing enough. But second, because the reason historically low interest rates are driven as much by the supply side as by the demand side of the economy. A different fiscal-monetary mix will not address supply-side challenges.
Those challenges can be encapsulated in the observation that the natural real rate of interest — the real rate that would prevail in conditions of steady-state growth with full employment — has fallen. As we pointed out recently, central bankers are increasingly taking this on board. Miles Kimball has posted a good overview of the Bank of England’s (and other central banks’) thinking on this, which underpins Mark Carney’s justification for low policy rates (while also undermining his opposition to negative ones). In brief: a lower natural rate must mean a lower policy rate for a given monetary policy stance (and a given fiscal-monetary mix).
Why have natural rates fallen? Part of the reason has to do with structural changes in economies, including ageing and the shift of national income shares towards those who save more. Productivity growth has also slowed down for reasons economists struggle to pin down, as Federal Reserve vice-chair Stanley Fischer discussed in his latest speech. If lower growth is here to stay, there will also be less production from which to compensate rentiers. We also know that businesses are not taking advantage of exceedingly low borrowing costs to invest. If savers are feeling euthanised, that is at least part of the reason.
This may not be entirely unrelated to inadequate demand-side policy. If business investment, or indeed TFP growth, is cyclically depressed because of low expectations of future demand, and these expectations are driven by overly timid stimulus policies, then more aggressive policy may indeed reverse the current low-rate predicament. What does this mean for the central bankers gathering in Jackson Hole? That blaming fiscal policymakers for doing too little is fine — but doing so as a way to avoid doing more themselves is not.
- Matt Levine riffs, as only he can, on the socialist calculation problem in the context of passive investing.
- Global youth unemployment is edging up again, after falling for the past three years.
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