It took just seven days for almost everyone in economics to agree that negative interest rates are a failure: They have not achieved their goal of flushing cash out of the banking system to fuel inflation and growth through cheap credit.
That lesson will be difficult for conservatives to swallow. It was the right — Thatcher and Reagan, specifically — who convinced us all back in the 1980s that conducting economics via central bank monetary policy and not through fiscal government spending was the correct course.
Now, with the negative interest rate experiment in tatters, it will be interesting to see if the Keynesians on the left can use this as a political victory to push for the kind of government-backed fiscal solutions that are beyond the powers of central banks.
First, let’s examine why negative interest rates have been such a failure, and then we’ll turn to the political repercussions for the conservatives who are to blame for them.
“Very costly for the national economy.”
On February 11, seven days ago, the Swedish central bank cut its interest rates more deeply into negative territory, and said it would cut further if need be. “There is still scope to cut the repo rate further,” the Riksbank threatened, while simultaneously acknowledging that it ever-cheaper credit was blowing up the housing market in Sweden, and that “such a development could ultimately be very costly for the national economy.”
“Damn the torpedoes, we’re diving deeper!” was the message everyone heard.
Since then, investment bank analysts have been lining up to say that none of it is working:
- The pack was led by HSBC’s James Pomeroy, who declared Sweden’s efforts a failure back in early January.
- Goldman Sachs’ Japan team thinks the negative rate there will have the opposite of the intended effect: “We believe the stimulatory impact on capex will be very limited in Japan, and the negative rate could even have a negative impact on spending,” they told investors today.
- Credit Suisse’s Helen Haworth and her team says negative rate expenses hurt bank profits, making them loathe to extend credit, thus exacerbating the problem they’re intended to fix: “lending growth remains very low, and we think that margin pressure is just one part of the problem,” according to CS today.
- Huw Van Steenis of Morgan Stanley, ex-head of the Minneapolis Federal Reserve Narayana Kocherlakota, and Chris Xiao and Vadim Iaralov at Bank of America Merrill Lynch, have all said, in one form or another, “this ain’t working.”
- David Bloom of HSBC said, “Policymakers have been disappointed. The simple fact is that negative rates have not prompted any lasting weakness in currencies.”
- Malcolm Barr and his team at JPMorgan published a paper this week that says the effect of negative rates thus far has been so muted that banks ought to push them as low as -4.5%, an insanely low level. “Calibrations based on Swiss experience suggest that with modest changes to the reserve regime, the policy rate in the Euro area could, in principle, go as low as -4.5%,” the JPMorgan paper says.
(That last one is a weird policy idea: when it doesn’t work, do more of it.)
It isn’t working because even though central banks are charging negative interest to commercial banks for storing cash, those commercial banks are refusing to pass on the charges to their customers. So the customers face no penalty for storing their cash and doing nothing with it. At the same time, banks that face negative interest rate exposure can avoid it by simply shifting their cash into anything that isn’t negative — bonds, foreign currencies, whatever.
In sum, negative interest isn’t transferring through into consumer price inflation.
Some of that extra, cheap cash is causing inflation, just the wrong kind of inflation. In Sweden, the Riksbank is obsessed with hitting its 2% inflation target. It seems not to care that the cheap mortgages its ultra-low rates have created are fuelling house-price inflation by 25% a year. All the inflation — except for today’s 0.8% blip — is being pushed into houses, not consumer prices, in other words. HSBC’s Pomeroy thinks this is “not sustainable.”
Ultra-low rates of interest have fuelled steep property booms in London and Germany, and the Americans are pouring money into risky private tech startups at high valuations, even though some of those startups lose billions of dollars a year.
In short, central banks have succeeded in creating inflation. Asset inflation, not consumer price index inflation.
It’s mostly Milton Friedman’s fault.
People forget that the reason we’re in this pickle — with half a dozen central banks suddenly out of weapons just as China looks like really wobbly — is because of an argument that conservatives won in the 1980s.
Prior to the election of Margaret Thatcher in the UK and Ronald Reagan in the US, the economic debate between left and right centred almost entirely on fiscal policy. The left favoured government spending and wealth redistribution to make society more fair; the right favoured a reduction in both of those in order to keep government finances both balanced and small.
Then Milton Friedman and monetarism came along. This conservative school of thought argued that fiscal spending was much less important than central bank policy.
A central bank could spur growth and inflation by lowering interest rates and making cash cheap to borrow. The free market would then decide the most efficient way to deploy that capital. Economic policy need not rely on large government budgets to function.
Over the next two decades, monetarism seemed to work really well. The 1990s in particular were a decade of peace and prosperity for the West.
Sure, there were two big market crashes in 2000 and 2007, when the dot-com and property bubbles collapsed. But the monetarists said those could have been avoided if central banks had been more sophisticated, and quicker to increase rates in order to snuff out those bubbles. Economics was reduced to an argument over monetarist timing and technique, rather than the larger principle of who exactly should be in control of capitalism — a bank or a government.
The power of monetary policy is that it works really well if interest or inflation is at 5%, for instance. You’ve got 500 basis points to play with, if you want to spur more growth; and even more above if you want to crush inflation. Once you get down to zero interest and zero inflation — where we are now — you’re screwed. No more basis points to lower, no more weapons. You’re sitting in a car with an empty tank, miles from the nearest petrol station.
So, what type of economic policy would create growth, fuel CPI, and juice stocks?
The obvious answer is to do it the old-fashioned way: fiscal stimulus from governments, in the form of government borrowing for spending on infrastructure. Railways, bridges, schools, hospitals, universities. All the things the free market is lousy at but that society needs anyway. All the things that provide the stable, civilised underpinning that a free market needs to function smoothly. And all that borrowing of new central bank cash might fuel a little inflation along the way. (The Chinese are trying that right now, in fact.)
Labour leader Jeremy Corbyn suggested doing something like this back in September, and — surprisingly — there are a few economists who think that this is not a completely mad idea.
It all depends on the quality of your government spending, of course. If a European government ramped up its debt to go war against Australia it would have a very different economic effect than if that debt were used to build new high-speed rail system. (Or a “garden bridge.”)
That issue — quality — has always been the left’s weak spot in economics, of course.
But with conservatives on the ropes due to monetary policy failures, there has never been a better opening for an anti-monetarist resurgence.
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