Helicopter drops might not be far away by Martin Wolf (2.23.16)
Why might the world be driven to such expedients? The short answer is that the global economy is slowing durably. The OECD now forecasts growth of global output in 2016 “to be no higher than in 2015, itself the slowest pace in the past five years”. Behind this is a simple reality: the global savings glut — the tendency for desired savings to rise more than desired investment — is growing and so the “chronic demand deficiency syndrome” is worsening.
This stage of demand weakness must be seen in its historical context. The long-term real interest rate on safe securities has been declining for at least two decades. It has been near zero since the financial crisis of 2007-09. Before then, an unsustainable western credit boom offset the weakness of demand. Afterwards, fiscal deficits, zero interest rates and expansions of central bank balance sheets stabilised demand in the west, while a credit expansion funded massive investment in China. Loose western monetary policies and loose Chinese credit policies also drove the post-crisis commodity boom, though China’s exceptional growth was the most important single factor.
The end of these credit booms is an important cause of today’s weak demand. But demand is also weak relative to a slowing growth of supply. At the world level, growth of labour supply and labour productivity have fallen sharply since the middle of the last decade. Lower growth of potential output itself weakens demand, because it lowers investment, always a crucial driver of spending in a capitalist economy.
It is this background — slowing growth of supply, rising imbalances between desired savings and investment, the end of unsustainable credit booms and, not least, a legacy of huge debt overhangs and weakened financial systems — that explains the current predicament. It explains, too, why economies that cannot generate adequate demand at home are compelled towards beggar-my-neighbour, export-led growth via weakening exchange rates. Japan and the eurozone are in that club. So, too, are the emerging economies with collapsed exchange rates. China is resisting, but for how long? A weaker renminbi seems almost inevitable, whatever the authorities say.
No simple solutions for the global economic imbalances of today exist, only palliatives. The current favourite flavour in monetary policy is negative interest rates. Mr Dalio argues that: “While negative interest rates will make cash a bit less attractive (but not much), it won’t drive . . . savers to buy the sort of assets that will finance spending.” I agree. I cannot imagine that businesses will rush to invest as a result. The same is true of conventional quantitative easing. The biggest effect of these policies is likely to be via exchange rates. In effect, other countries will be seeking export-led growth vis-à-vis over-borrowed US consumers. That is bound to blow up.
One alternative then is fiscal policy. The OECD argues, persuasively, that co-ordinated expansion of public investment, combined with appropriate structural reforms, could expand output and even lower the ratio of public debt to gross domestic product. This is particularly plausible nowadays, because the major governments are able to borrow at zero or even negative real interest rates, long term. The austerity obsession, even when borrowing costs are so low, is lunatic (see chart).
If the fiscal authorities are unwilling to behave so sensibly — and the signs, alas, are that they are not — central banks are the only players. They could be given the power to send money, ideally in electronic form, to every adult citizen. Would this add to demand? Absolutely. Under existing monetary arrangements, it would also generate a permanent rise in the reserves of commercial banks at the central bank. The easy way to contain any long-term monetary effects would be to raise reserve requirements. These could then become a desirable feature of our unstable banking systems.
The main point is this. The economic forces that have brought the world economy to zero real interest rates and, increasingly, negative central bank rates are, if anything, now strengthening. This is what the world economy is showing. This is what monetary policy is indicating. Increasingly, this is what asset prices are demonstrating.
Policymakers must prepare for a new “new normal” in which policy becomes more uncomfortable, more unconventional, or both. Can the world escape from the chronic demand weakness? Absolutely, yes. Will it? That demands greater boldness. When one has exhausted the just about possible, what remains, however improbable, must be the answer.