Is moderate monetary policy better than going to the
extremes? The same can be asked of fiscal policy. Moreover, is a hypertrophic
urge to prompt economic growth as if it were an end in itself better than
seeking an economic equilibrium? Generally speaking, systems in equilibrium are
more stable than those that include a schizogenic, or limitlessly maximizing,
variable. An example of the latter is the population growth of our species
relative to the equilibria otherwise established by the ecosystems in which we
live. A desire for economic growth is a maximizing variable in a political
economy. So too is the related practice of taking monetary (and fiscal) policy
to an extreme. If the desire is great enough and the related policies extreme
enough, the equilibrium of a political economy can be punctured with systemic
risk increasing as does the instability of the system. I contend, therefore,
that moderate government and central bank policies are preferable to going to
the extremes. Here, I address monetary policy.
As Raghuram Rajan stepped down on September 4, 2016 as
India’s central banker, he warned the world—and especially the U.S. and E.U.—
against keeping interest rates low as a way to encourage growth. He claimed
that low interest rates globally could distort markets and are difficult to
raise. Central bankers setting interest rates low to stimulate economic growth
can become “trapped” out of fear that raising the rates would slow economic
growth.[1]
This is ultimately a defect of democracy itself—the inflicting of necessary
“pain” on the electorate being very difficult politically. Hence, for example,
the U.S. Federal Reserve Bank at the time was caught in its “long-running
dilemma about whether the labor market [could] easily withstand another
interest-rate increase” even though many policy makers believed that the
economy was nearing full employment.[2]
That the market nonetheless expected that the Fed would “push off a rate
increase until December” demonstrates just how politically difficult raising
rates can be even when they are extremely low and the economy is near
full-employment.
Given such political sensitivity, Rajan urged central
bankers and government officials not to use low interest rates as a substitute
for “other instruments of policy” and ‘various kinds of reforms” that are
needed to encourage growth; it is simply too difficult politically to increase
such “good” rates.[3]
Relying too much on one policy lever, moreover, is not wise because doing so
could introduce a maximizing variable that could compromise the equilibrium of
a political economy.
As one example of why going to extremes on monetary policy
is not a good idea, Japan was issuing negative interest-rate bonds at the time,
which some investors were actually buying. Such bonds do not pay interest, and
the principal returned is less than that which the investor paid for the bond.
Willing investors were betting that their purchases would stimulate other
investors to buy, so the price of the bonds would go up (the original investors
would then sell for a profit).
Yet another instance concerns companies in the E.U. that were
issuing bonds with negative interest-rates. Investors were “paying for the
privilege of lending their money to companies.”[4]
This is clearly dysfunctional from a financial standpoint. Edward Farley, head
of European corporate bonds at PGIM Fixed Income, said, “It seems pretty
bizarre to ask a corporate to look after your money and give you back less in
two or three years’ time.”[5]
To be sure, the E.U.’s central bank had expanded its bond-buying to corporate
debt over the previous summer, hence “creating more demand for bonds and
pushing down their yields.”[6]
This does not explain the investors’ bizarre behavior in buying bonds with
negative interest-rates. Something else was behind the oddity; something was
wrong, financially speaking. The Wall Street Journal makes the source of the
problem explicit, noting at the time that the negative interest-rates were a “sign
of how aggressive central-bank policy is upending conventional patterns in
finance.”[7]
We can substitute “extreme” for aggressive, and we have an explicit link
between upending conventional behavior in finance and a central bank going to
extreme measures.
Another example of a warping of finance concerns savings
accounts. When the price of money reaches an extreme low, people have less
incentive to put money into a savings account. Consumption is artificially
stimulated while saving is discouraged. This imbalance can through off the
equilibrium of a stable economy. Furthermore, it is not fair to penalize one
sector of a financial system (i.e., savers) while making it easier for another
sector (mortgage holders). Put another way, the efforts to stimulate economic
growth should not be borne on one group in the economy while another group
benefits.
In general, going to an extreme in monetary policy, such as
when a government relies exclusively on low interest rates to spur economic
growth, is not wise because setting a variable in the economy at an extreme can
cause the economy to become distorted. This in turn can rip a tear in the
economy’s equilibrium. The solution is not just to balance the use of monetary
and fiscal policy; resisting the temptation to go to extremes in demanding
economic growth may also be needed.
At that more fundamental level, achieving and sustaining an
equilibrium at the macro level (i.e., the economy or political economy) should
be valued more when monetary or fiscal policy is being pushed to extremes. At
that level, societal values, rather than merely political platforms and
central-bank policies, must be changed; otherwise, electorates will continue to
pressure politicians and central bankers to do what they have to in order to
get more economic growth. To be sure, voters want more jobs, and thus a growing
economy, so the societal values that support the demand beyond that which is in
keeping with maintaining equilibrium are not easily changed. I submit that the
existing societal values in advanced economies lapse in failing to recognize
that equilibrium is elastic within limits. So to a certain extent growth vs.
equilibrium, or increase vs. balance is a false dichotomy.
To be sure, the economic growth that is in keeping with
growing the existing equilibrium rather than piercing through it is not
necessarily enough for full employment to be achieved. As per the U.S. Full Employment
Act of 1946, governments may need to step in to fill the gap such that everyone
who wants a job can have one, even if the government is the employer. Franklin
Roosevelt understood this in the Great Depression of the 1930’s, so he
instituted the CCC and other programs in his New Deal. With governments
stepping up to the plate, voters might not insist that their elected
representatives and their appointees in turn set monetary or fiscal policy to
an extreme level in order to pump up an economy beyond an undistorted
equilibrium. Like someone who tries too hard, pushing monetary or fiscal policy
to an extreme may ultimately be worse economically than had the devices been
used moderately.
[1]
Geeta Anand, “A Departing Central Banker’s Warning,” The New York Times, September 5, 2016.
[2]
Eric Morath, “Jobs Data Cool Odds on Rate Rise,” The Wall Street Journal, September 3-4, 2016.
[3] Anand,
“A Departing Central Banker’s Warning.”
[4]
Christopher Whittall, “European Firms Borrow at Subzero Rates,” The Wall Street Journal, September 7,
2016.
[5]
Ibid.
[6]
Ibid.
[7]
Ibid.
