Monetary Stimulus and Missing Growth
By: Henry Beckett
It is a tenet of macroeconomic theory as well as one of the key presumed levers of central banks that low interest rates stimulate investment, which will lead to job growth and lower unemployment. But 6 years and many trillions of dollars in monetary stimulus later, we still find ourselves in a world tipping toward disinflation, or even outright deflation, as in Japan.
In April 2013, the Bank of Japan announced the injection of 270 Trillion Yen ($2.7 Trillion) to be spread over 2 years. Then again on October 31 of this year, Japan’s central bank announced it would pump trillions more Yen into the economy in an effort to fight its decades-long deflation menace. Deflation is when the general price level is falling. And although it sounds at first blush like good news because everyone can afford to purchase more goods and services, deflation is very dangerous. First is the problem of expectations: if people think prices will fall, they will hold back spending and borrowing. This decreases demand, which lowers prices further, and can lead to a “deflationary spiral” in which economies stay under pressure because people anticipate deflation, and deflation continues because the underlying economy remains weak. Second, in a deflationary environment the real value of debt rises. Rising prices favor debtors: the money their obligations need to be paid in will be worth less than the money they borrowed. Deflation has the opposite effect. Real debt burdens grow. And lastly, in order to adjust to deflation, wages need to go down as well. But this turns out to be very difficult in practice because of nominal wage “stickiness”. So instead of wage decreases, the result is worsening unemployment. This has been a key cause of the nearly 25% unemployment rate in Spain that persists 6 years after 2008.
US Federal Reserve chair Ben Bernanke pronounced at a conference to honor the father of monetary economics Milton Friedman, “the idea that monetary forces, particularly if unleashed in a destabilizing direction, can be extremely powerful. The best thing that central bankers can do for the world is to avoid such crises by providing the economy with, in Milton Friedman’s words, a “stable monetary background”…Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”
So, with the work of Friedman as their inspiration, in the wake of the 2008 collapse and ensuing recession Bernanke and other central bankers around the world have been adding unprecedented levels of monetary stimulus both by holding interest rates at zero or near-zero levels and by purchasing bonds and other forms of debt in the open market in an effort to fight deflation and get economies back on a healthy growth track with moderate inflation. The overnight Fed Funds rate has been near zero for 5 years.
Long term bond market-driven rates have hovered between 1.5 and 3% over the same time period, signaling that markets don’t expect inflation or robust growth anytime soon.
So the question is, with so much monetary stimulus, where’s the growth? Even in the US, the one place the economy seems to be clearly doing better, a lot of the optimism about the improvement in unemployment is mitigated by the fact that there’s been almost no growth in the real median real wage growth in decades. Real median household income is approximately $52,500, the same as it was in 1988. So it makes sense to ask: was all the stimulus for nothing?
Well, one place there has been strong price growth is in securities markets. The S&P 500 seems to hit a new high nearly every week recently. Bonds also have a very strong bid, with interest rates across the curve still extremely low by historical norms. But high bond prices and high equity prices together sends a strongly mixed message. High AAA-rated bond prices usually denotes fears about growth, as investors signal concern about liquidity and preservation of capital. But historically equity market growth signals the market’s belief that the broader economy will recover and grow in the near future. How to explain this paradox?
One possibility is that that a large portion of the monetary stimulus may have found its way into asset markets and is bidding up prices in both equities and fixed income, but for different reasons. Unquestionably the yield curve shows there is great demand for safe assets. And because cash is a money-losing asset class at these interest rates, huge amounts of money have flowed into equity markets,in particular looking for dividends that surpass what they can earn in bonds or at the bank. This reach for yield is only likely to continue as the baby boom generation starts to retire en masse, something which is only a few years away.
But the people in the lower and middle economic strata — the ones who most needed the stimulus to work so jobs and opportunity would be created — are not beneficiaries of gains in capital markets. Instead they contend with a global economy still fighting stagnation and disinflation. Worse, as Piketty warns in his groundbreaking book Capital, global inequality is at levels not seen since the Gilded Age, and will just continue to worsen unless governments fight against it through fiscal policy, something that has proven politically difficult in many countries.
So in the meantime we wait with fingers crossed that the unprecedented global monetary stimulus finds its way not just into asset prices, but eventually into the global economy at large, so that it fulfills its intended purpose.