tag:theconversation.com,2011:/ca/topics/qe-12247/articlesQE – The Conversation2022-09-25T20:07:09Ztag:theconversation.com,2011:article/1910612022-09-25T20:07:09Z2022-09-25T20:07:09ZWhy the Reserve Bank’s record loss of $37 billion was actually good for Australia<figure><img src="https://images.theconversation.com/files/486215/original/file-20220923-367-zn3w0w.png?ixlib=rb-1.1.0&rect=107%2C604%2C3419%2C1742&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">Mick Tsikas/AAP</span></span></figcaption></figure><p>The Reserve Bank has just reported a loss of <a href="https://www.smh.com.au/politics/federal/reserve-bank-s-bond-program-helped-save-jobs-and-economy-20220921-p5bjpg.html">A$37 billion</a>, the biggest in its history, and it says it will be unable to pay the government dividends for some time.</p>
<p>The announcement followed a review of its bond-buying program, one of the most important ways it supported the economy during the first two years of the pandemic.</p>
<p>In order to borrow to fund programs such as JobKeeper, the government borrowed on the bond market, issuing bonds on the money market that the Reserve Bank later bought with newly created money. That meant the Reserve Bank was, indirectly, the largest financier of the expanded budget deficit.</p>
<p>The <a href="https://www.rba.gov.au/monetary-policy/reviews/bond-purchase-program/">review</a> concluded the bond-buying program worked relatively well. By aggressively buying $281 billion of bonds, the Reserve Bank was able to not only make sure government programs were funded, but also lower the general level of interest rates in the bond market, supporting the economy.</p>
<h2>How did buying bonds help?</h2>
<p>The review found buying bonds on the money market </p>
<ul>
<li><p>encouraged traders to put their money into other parts of economy, such as investing in Australian firms</p></li>
<li><p>sent a signal to the market that interest rates would be low for a long time, encouraging firms to invest, confident they will be able to borrow cheaply for years to come</p></li>
<li><p>gave investors confidence that, if they bought bonds, they could sell them later to the bank if needed.</p></li>
</ul>
<p>The report suggests the $281 billion dollars of bond purchases lowered long-term bond rates by around 0.3 percentage points. </p>
<p>This in turn helped lower the value of the Australian dollar by 1-2%, supported business investment, and encouraged consumers to spend, and boosted gross domestic product by a cumulative $25 billion.</p>
<h2>What about the downsides?</h2>
<p>The report found the Reserve Bank made a substantial loss on the bond-buying program, estimated to be as high as $54 billion. Its overall loss this financial year will approach $37 billion.</p>
<p>How can a bank make a loss when it is <a href="https://theconversation.com/the-mint-and-note-printing-australia-make-billions-for-australia-but-it-could-be-at-risk-190901">printing money</a>?</p>
<p>The answer is that it lost money by buying high and selling low – the opposite of traditional investment advice!</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/more-than-a-rate-cut-behind-the-reserve-banks-three-point-plan-134140">More than a rate cut: behind the Reserve Bank's three point plan</a>
</strong>
</em>
</p>
<hr>
<p>During the crisis investors fled to the safety of the Australian bond market, wanting to put their money somewhere safe: Australian government bonds. </p>
<p>This meant the bank bought bonds at high prices. As the economy recovered and investors ploughed their money back into the stock market and other more risky places, bond prices dropped, giving the bank an accounting loss on the bonds.</p>
<p>While the Reserve Bank doesn’t plan to sell the bonds (it’ll hold them until they mature), if it did, it would have to sell them for much less.</p>
<h2>Bankrupt? Not really</h2>
<p>The bank is still perfectly capable of operating even if it loses money on investments. Being able to print money at will means it can’t go broke.</p>
<p>But it is unlikely to provide the government with a dividend from its profits for several years. Usually the bank makes a profit from printing money. The notes cost about <a href="https://theconversation.com/the-mint-and-note-printing-australia-make-billions-for-australia-but-it-could-be-at-risk-190901">32 cents</a> each to print and it offloads them for as much as $50 and $100. </p>
<p>It will use this income to soak up the losses from its bond-buying program, and won’t need to ask the government for more.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/the-mint-and-note-printing-australia-make-billions-for-australia-but-it-could-be-at-risk-190901">The Mint and Note Printing Australia make billions for Australia – but it could be at risk</a>
</strong>
</em>
</p>
<hr>
<p>This review confirms that bond-buying will remain an important part of the bank’s toolkit. While inflation today is soaring and interest rates are being increased at a breakneck pace, it is highly likely that at some point in the future the economy will go through a rough patch and need lower rates.</p>
<p>When the bank has cut its short-term cash rate to near-zero, as it did in 2020, it’ll need to do something else to bring down other longer-term rates.</p>
<p>It says it will buy bonds only “in extreme circumstances, when the usual monetary policy tool – the cash rate target – has been employed to the full extent possible”, but it concedes it may have to, and it believes what it did was worthwhile.`</p><img src="https://counter.theconversation.com/content/191061/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Isaac Gross does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>How could a central bank even make a loss, when its job is printing money? The answer is that during the COVID crisis it turned traditional investment advice on its head – and here’s why.Isaac Gross, Lecturer in Economics, Monash UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1655092021-08-03T13:33:23Z2021-08-03T13:33:23ZFour reasons why EU is staring down the barrel of a second lost decade<figure><img src="https://images.theconversation.com/files/414326/original/file-20210803-13-16cys9.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Rolling the dix. </span> <span class="attribution"><a class="source" href="https://unsplash.com/photos/p-ER1gHMTYY">Imelda</a>, <a class="license" href="http://creativecommons.org/licenses/by-sa/4.0/">CC BY-SA</a></span></figcaption></figure><p>The eurozone’s latest <a href="https://www.reuters.com/world/europe/euro-zone-rebounds-strongly-inflation-above-ecb-target-2021-07-30/">economic growth figures</a> are a little better than expected. This group of 19 EU nations grew 2.2% in the second quarter of 2021 compared to the first quarter, partly thanks to decent performances from Spain and Italy. </p>
<p>But while the US and Chinese economies are both now bigger than their 2019 peaks, the eurozone is 3% off that achievement. And when you look more broadly at the state of the eurozone, this turns out to be only the tip of the iceberg. </p>
<iframe id="noa-web-audio-player" style="border: none" src="https://embed-player.newsoveraudio.com/v4?key=x84olp&id=https://theconversation.com/four-reasons-why-eu-is-staring-down-the-barrel-of-a-second-lost-decade-165509&bgColor=F5F5F5&color=D8352A&playColor=D8352A" width="100%" height="110px"></iframe>
<p>COVID-19 still overshadows everything around the world, but countries are likely to recover at <a href="https://theconversation.com/covid-19-recovery-some-economies-will-take-longer-to-rebound-this-is-bad-for-everyone-162023?utm_source=linkedin&utm_medium=bylinelinkedinbutton">different speeds</a> once we get back to some sort of normality. This will depend on the structure of their economies, the effectiveness of their recovery policies, and how they <a href="https://www.project-syndicate.org/commentary/stagflation-debt-crisis-2020s-by-nouriel-roubini-2021-06?utm_source=Project+Syndicate+Newsletter&utm_campaign=579926b478-covid_newsletter_07_01_2021&utm_medium=email&utm_term=0_73bad5b7d8-579926b478-105568073&mc_cid=579926b478&mc_eid=14a09c8529">deal with</a> high sovereign debts and a foreseeable mix of weakish growth and inflation. But for several reasons, the eurozone particularly worries me. </p>
<h2>Ghosts of the past</h2>
<p>The first is the eurozone’s bleak performance since the global financial crisis of 2007-09. It took six years to regain its 2008 GDP level, and some members did even worse: Spain and Portugal took almost a decade, and Italy and Greece have yet to get there.</p>
<p>When COVID broke out, the eurozone growth rate remained well below its long-term trajectory. It was behind the US and UK, both of whom were hit harder by the global financial crisis, and even worse compared to the leading emerging economies. Neither was this a one-off. Looking at the <a href="https://eabcn.org/sites/default/files/eabcdc_findings_29_march_2021.pdf">past five</a> recessions, the eurozone nations have been successively slower to recover from each one. </p>
<p><strong>GDP by nation since 2008</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/414307/original/file-20210803-17-vo2ofo.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/414307/original/file-20210803-17-vo2ofo.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/414307/original/file-20210803-17-vo2ofo.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=296&fit=crop&dpr=1 600w, https://images.theconversation.com/files/414307/original/file-20210803-17-vo2ofo.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=296&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/414307/original/file-20210803-17-vo2ofo.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=296&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/414307/original/file-20210803-17-vo2ofo.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=372&fit=crop&dpr=1 754w, https://images.theconversation.com/files/414307/original/file-20210803-17-vo2ofo.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=372&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/414307/original/file-20210803-17-vo2ofo.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=372&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Based on GDP (constant 2010 US$): Source: Authors’ calculations using World Bank data.</span>
<span class="attribution"><span class="source">Muhammad Ali Nasir</span></span>
</figcaption>
</figure>
<p>Since 2008, the ECB has tried numerous measures to improve growth. Like most major powers, it has done a lot of <a href="https://www.ecb.europa.eu/explainers/show-me/html/app_infographic.en.html#:%7E:text=These%20asset%20purchases%2C%20also%20known,but%20close%20to%2C%202%25.&text=The%20European%20Central%20Bank%20buys%20bonds%20from%20banks.&text=This%20increases%20the%20price%20of,money%20in%20the%20banking%20system.">quantitative easing</a> (QE), which involves creating money to buy sovereign bonds and other financial assets. <a href="https://www.ecb.europa.eu/mopo/ela/html/index.en.html">It has</a> sought to <a href="https://www.ceps.eu/whats-the-ecb-doing-in-response-to-the-covid-19-crisis/">prop up</a> its <a href="https://www.ecb.europa.eu/mopo/implement/omo/tltro/html/index.en.html#:%7E:text=The%20targeted%20longer%2Dterm%20refinancing,lending%20to%20the%20real%20economy.">retail banks</a> in <a href="https://www.federalreserve.gov/monetarypolicy/files/FOMC20100805memo02.pdf">various ways</a>, while also pioneering <a href="https://www.reuters.com/world/europe/how-do-negative-interest-rates-work-2021-02-04/#:%7E:text=The%20ECB%20introduced%20negative%20rates,term%20rate%20to%20about%20zero.">negative interest rates</a> and giving the markets more <a href="https://www.ecb.europa.eu/explainers/tell-me/html/what-is-forward_guidance.en.html">forward guidance</a> about monetary policy. </p>
<p>Famously in 2012, then ECB president <a href="https://www.politico.eu/article/ecb-will-do-whatever-it-takes-to-save-the-euro/">Mario Draghi said</a> he would do “whatever it takes” to save the euro. This forward guidance kept the euro stable, but the same cannot be said of growth. </p>
<h2>Poor policy and low ammunition</h2>
<p>Policy errors are partly to blame for this. With the benefit of hindsight, the eurozone went into the global financial crisis with lending rates on the low side, so had less room to cut than other regions. It was also more reluctant than central banks like the Bank of England and US Federal Reserve to start QE, preferring to focus on curbing inflation and making the euro “<em>stabil wie die mark</em>” (stable like the German mark). The ECB did not unveil a QE programme <a href="https://www.bbc.co.uk/news/business-30933515">until 2015</a>.</p>
<p>Countries with the capacity to spend to stimulate their economies, such as Germany, France and the Netherlands, also did too little. Spain’s stimulus was poorly designed, while Italy was more interested in balancing its books at the time. Too soon after the crisis struck, <a href="https://www.ncbi.nlm.nih.gov/pmc/articles/PMC4952125/">austerity then became</a> the priority for the whole eurozone. </p>
<p>A related problem has been public and private investment. In middle-income EU regions, investment rates <a href="https://www.eib.org/attachments/efs/economic_investment_report_2019_en.pdf">fell by</a> about 14% between 2002 and 2018. <a href="https://www.bruegel.org/2018/06/understanding-the-lack-of-german-public-investment/">In thrifty Germany</a>, public and private fixed investments declined as a percentage of GDP for decades, despite a huge surplus in public spending. </p>
<p>Before COVID hit, EU infrastructure investment was at <a href="https://www.eib.org/attachments/efs/economic_investment_report_2019_en.pdf">a 15-year low</a>, with the greatest declines in regions that were already lagging. Initiatives intended to help, such as the <a href="https://ec.europa.eu/economy_finance/publications/pages/publication13504_en.pdf">European Economic Recovery Plan</a> of 2008 and the <a href="https://ec.europa.eu/info/investment-plan_en">European Commission Investment Plan</a> in 2014, were too little.</p>
<p>The overall result was that weakness: Germany and the eurozone as a whole were showing 0% growth at the time of the COVID outbreak, while Austria, France and Italy were all contracting slightly. In response, the <a href="https://www.ecb.europa.eu/press/pressconf/2019/html/ecb.is190912%7E658eb51d68.en.html">ECB had cut</a> its main interest rate by 0.1 percentage points to -0.5% in September 2019, and restarted monthly QE to the tune of €20 billion (£17 billion) from November 1 of that year – the date Christine Lagarde became ECB president. </p>
<p>The eurozone economy was therefore needing life support even before the pandemic – indeed, many of the ECB’s other unconventional support measures were in place throughout. Tellingly, the ECB’s only new measure during the pandemic has been a <a href="https://www.ecb.europa.eu/press/pr/date/2020/html/ecb.pr200430_1%7E477f400e39.en.html">new form</a> of cheaper refinancing for banks. It raises the prospect of the ECB <a href="https://www.piie.com/publications/policy-briefs/are-central-banks-out-ammunition-fight-recession-not-quite">running out</a> of the ammunition needed to keep stimulating the eurozone’s sickly economy. </p>
<h2>Discipline <em>über alles</em></h2>
<p>Finally, some eurozone members are obsessed with the EU’s <a href="https://voxeu.org/article/fiscal-rules-european-monetary-union#:%7E:text=Mauro%2C%20Jeromin%20Zettelmeyer-,Fiscal%20rules%20were%20enshrined%20in%20the%20founding%20documents%20of%20the,deficits%20below%203%25%20of%20GDP.">fiscal rules</a> around low national debt and low deficits. The Financial Times <a href="https://www.ft.com/content/dacd2ac6-6b5f-11ea-89df-41bea055720b">may have reported</a> in March 2020 that “Germany tears up fiscal rule book to counter coronavirus pandemic”, but there are <a href="https://www.ft.com/content/640d084b-7b13-4555-ba00-734f6daed078">already calls</a> by influential figures such as Bundestag president Wolfgang Schäuble to return to fiscal discipline. </p>
<p>A rush to austerity 2.0 is a luxury that the EU cannot afford. To quote something <a href="https://quoteinvestigator.com/2017/03/23/same/#note-15768-1">often attributed</a> to Albert Einstein, insanity is doing the same thing over and over again and expecting different results. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/414322/original/file-20210803-16-1jz2v4k.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="German flag on top of the Reinchstag at dusk" src="https://images.theconversation.com/files/414322/original/file-20210803-16-1jz2v4k.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/414322/original/file-20210803-16-1jz2v4k.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/414322/original/file-20210803-16-1jz2v4k.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/414322/original/file-20210803-16-1jz2v4k.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/414322/original/file-20210803-16-1jz2v4k.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/414322/original/file-20210803-16-1jz2v4k.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/414322/original/file-20210803-16-1jz2v4k.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Germans don’t do inflation.</span>
<span class="attribution"><a class="source" href="https://unsplash.com/photos/G6RE_to6Lus">Christian Lue</a>, <a class="license" href="http://creativecommons.org/licenses/by-sa/4.0/">CC BY-SA</a></span>
</figcaption>
</figure>
<p>For different results, the ECB should stand its ground on monetary easing and, like the Fed, avoid giving in to inflationary pressures that are likely to be short term by raising rates or paring back QE. </p>
<p>Meanwhile, the fiscal rules need loosening to correspond to economic realities. The temptation must be avoided to throw the nations in the peripheries under the austerity bus again, one of the main causes of the eurozone crisis of the early 2010s. </p>
<p>Surplus nations, particularly Germany, should revive spending in infrastructure, education and technology. The EU’s €750 billion <a href="https://europa.eu/next-generation-eu/index_en">Next Generation EU</a> investment plan will belatedly kick in later this year, but just like the two previous EU recovery packages, will probably not be enough on its own. </p>
<p>With an unimpressive track record on recovery, inherently weak economies, an obsession with fiscal rules and the prospect of the ECB running out of ammunition, the alternative could be a second lost decade. What that could do to the eurozone and the EU, it would be better not to find out.</p><img src="https://counter.theconversation.com/content/165509/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Muhammad Ali Nasir does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>If insanity is doing the same thing over and over and expecting different results, what does that say about the EU?Muhammad Ali Nasir, Associate Professor in Economics and Finance, University of HuddersfieldLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1614612021-05-31T08:12:16Z2021-05-31T08:12:16ZInflation might well keep rising in 2021 - but what happens after that?<figure><img src="https://images.theconversation.com/files/403137/original/file-20210527-13-1c7rscz.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Prices, prices, prices. </span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/empty-supermarket-aislemotion-blur-154411871">06photo</a></span></figcaption></figure><p>The US Federal Reserve has <a href="https://www.cnbc.com/2021/05/05/clarida-the-fed-is-a-long-way-from-our-goals-and-tightening-policy.html">just reassured</a> the markets that it doesn’t expect inflation to get out of hand in the coming months. It comes as concerns about serious inflation damaging the global economy have reached fever pitch, particularly since recent <a href="https://www.bls.gov/news.release/pdf/cpi.pdf">Labor Department data</a> showed that American inflation rose 4.2% over the 12 months ended April – the highest since the global financial crisis of 2007-09. In the euro area, <a href="https://www.europarl.europa.eu/RegData/etudes/STUD/2020/652753/IPOL_STU(2020)652753_EN.pdf">inflation seems certain</a> during the rest of this year to break out above the <a href="https://www.dw.com/en/ecb-holds-interest-rate-at-record-0-low/a-56839395">European Central Bank target</a> of “close to but below 2%”.</p>
<p>Central bankers on <a href="https://www.federalreserve.gov/newsevents/speech/clarida20210512a.htm">both sides</a> of the Atlantic <a href="https://on.ft.com/33MvT6v">say that</a> these price rises are a temporary consequence of the whiplash effect of the COVID-19 pandemic on demand. Supply chains in everything from commodities to semiconductors have been disturbed by demand first collapsing and then surging back, making prices very volatile. On this rationale, inflation will settle down once the pandemic recedes. </p>
<p>Critics <a href="https://www.bloomberg.com/news/articles/2021-03-20/summers-says-u-s-facing-worst-macroeconomic-policy-in-40-years?sref=6rqzlhe9">point to</a> the risks of price pressures setting off a chain reaction where everyone expects future price rises, causing a true inflationary episode where prices persistently increase across the board. </p>
<p>This debate about the near-term outlook is matched by an equally lively debate about long-term inflation, relating to drivers such as the effect of baby boomers retiring, <a href="https://blogs.lse.ac.uk/businessreview/2020/09/18/the-great-demographic-reversal-and-what-it-means-for-the-economy/">China’s changing labour force</a>, <a href="https://www.zdnet.com/article/unstoppable-tech-driven-deflation-will-be-the-next-economic-challenge/">automation</a> and so on. So who is right in all this? Are the inflation numbers a blip or are we seeing a gathering storm?</p>
<h2>Lessons of the 2010s</h2>
<p>In <a href="https://press.princeton.edu/books/hardcover/9780691145402/remembering-inflation">Remembering Inflation</a>, a book I published in 2013, I attempted to weave together various strands of this subject by looking at the breakthroughs in economists’ thinking about the causes and cures of inflation inspired by the “<a href="https://corporatefinanceinstitute.com/resources/knowledge/economics/stagflation/">stagflation</a>” of the 1970s, where inflation and unemployment both sharply increased.</p>
<p>My timing with that book was poor. The global economy’s faltering recovery from the global financial crisis was characterised by the opposite problem – <a href="https://theconversation.com/inflation-or-deflation-which-would-be-worse-right-now-138030">deflation</a> – where people expect prices to fall. As overstretched firms and households retrenched during the early 2010s, it should have fallen to governments to generate needed demand by ramping up public spending. Instead, fashionable notions of balancing the books using austerity got in the way.</p>
<p><strong>UK inflation rate 1960-2021</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/403131/original/file-20210527-15-1cfm7wg.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="UK inflation chart since 1960" src="https://images.theconversation.com/files/403131/original/file-20210527-15-1cfm7wg.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/403131/original/file-20210527-15-1cfm7wg.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=340&fit=crop&dpr=1 600w, https://images.theconversation.com/files/403131/original/file-20210527-15-1cfm7wg.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=340&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/403131/original/file-20210527-15-1cfm7wg.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=340&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/403131/original/file-20210527-15-1cfm7wg.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=427&fit=crop&dpr=1 754w, https://images.theconversation.com/files/403131/original/file-20210527-15-1cfm7wg.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=427&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/403131/original/file-20210527-15-1cfm7wg.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=427&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.macrotrends.net/countries/GBR/united-kingdom/inflation-rate-cpi">Macro Trends</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
</figcaption>
</figure>
<p><strong>US inflation rate 1960-2021</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/403135/original/file-20210527-19-1w1bp99.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="US inflation rate graph 1960-2021" src="https://images.theconversation.com/files/403135/original/file-20210527-19-1w1bp99.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/403135/original/file-20210527-19-1w1bp99.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=343&fit=crop&dpr=1 600w, https://images.theconversation.com/files/403135/original/file-20210527-19-1w1bp99.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=343&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/403135/original/file-20210527-19-1w1bp99.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=343&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/403135/original/file-20210527-19-1w1bp99.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=431&fit=crop&dpr=1 754w, https://images.theconversation.com/files/403135/original/file-20210527-19-1w1bp99.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=431&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/403135/original/file-20210527-19-1w1bp99.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=431&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.macrotrends.net/countries/GBR/united-kingdom/inflation-rate-cpi">Macro Trends</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
</figcaption>
</figure>
<p>Central banks were left to do the heavy lifting through cutting headline interest rates and using unconventional monetary policies like quantitative easing (QE) – that is, “printing money” – to buy large quantities of government bonds and other financial assets. </p>
<p>This helped to drive down long-term interest rates – even into negative territory in Europe – making things like mortgages and business loans cheaper. Yet the only “inflation” that resulted was rising asset prices in everything from property to stocks and shares. It made the rich richer, engendering <a href="https://positivemoney.org/2021/02/qe-or-not-to-qe-soaring-inequality-proves-its-time-for-a-new-macroeconomic-approach/">even wider inequalities</a> than before. </p>
<p>All the while, official consumer price inflation – which refers to the average change in prices of a basket of specific household goods – remained persistently below the 2% level targeted by the major central banks. According to what is known as the <a href="https://www.economicsonline.co.uk/Global_economics/Phillips_curve.html">Phillips curve</a>, inflation should have been stimulated by the fact that unemployment fell in countries <a href="https://www.statista.com/statistics/279990/unemployment-rate-in-the-uk-by-country/">such as the UK</a>, but it turned out this relationship had been suspended. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/402930/original/file-20210526-23-12aytf9.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Row of houses with For Sale signs" src="https://images.theconversation.com/files/402930/original/file-20210526-23-12aytf9.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/402930/original/file-20210526-23-12aytf9.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=449&fit=crop&dpr=1 600w, https://images.theconversation.com/files/402930/original/file-20210526-23-12aytf9.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=449&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/402930/original/file-20210526-23-12aytf9.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=449&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/402930/original/file-20210526-23-12aytf9.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=564&fit=crop&dpr=1 754w, https://images.theconversation.com/files/402930/original/file-20210526-23-12aytf9.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=564&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/402930/original/file-20210526-23-12aytf9.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=564&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">House prices boomed in the 2010s.</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/tejvan/8578204312/in/photolist-e52xhm-zGceL-4YeBQm-pbpk38-oZb6Fy-5myjWm-nUxbrq-5gM8Jg-79J1Sx-4iZLxZ-5mynwY-86DGun-5GN16M-8Tc68h-6wQPqv-66RtVu-7fZRt7-dHyj4v-4KXfFf-2Aevoe-dfqBsT-8cqNWo-5mu5Gp-8YhVM2-295eLk-ruzWaz-ddgUgM-5ya74B-ntYyNa-EnqS4-cUAY5w-tjbd1-2a71uVU-4yHWQ-6GC64k-Jc4mkf-CByXPF-Jnethw-Bx1Xwh-JatM-6W9VCy-9q3rVo-Y17z-AKbszg-eF5xtR-4y6ts5-h3LFVs-dGYStb-5wEh6j-v2ZJWn">Tejvan Pettinger</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
</figcaption>
</figure>
<p>One reason - particularly apparent <a href="https://tradingeconomics.com/united-states/labor-force-participation-rate">in the US</a> - was that the falling rate of unemployment was flattered by increasing numbers of people giving up looking for work and dropping out of the labour force altogether. This was a symptom of the core problem of insufficient demand from businesses and consumers. </p>
<p>A related symptom was the structural shift in the labour market. Where new jobs were created – sometimes, as in the UK, even <a href="https://www.ceicdata.com/en/indicator/united-kingdom/labour-force-participation-rate">to the extent</a> bringing people back into the labour force – these were concentrated in low-skilled and low-paid openings in sectors like leisure, hospitality and logistics. Increased demand for such services was the meagre limit of the “trickle-down” effect from ever-richer asset owners. </p>
<p>All this meant that there was not much <a href="https://www.statista.com/chart/16458/cumulative-real-pay-loss-in-the-uk/">real wage growth</a> which, along with associated increases in bank lending, is essential for creating inflation. So it was that, in the 2010s, monetary policy not only failed to stimulate the economy but actually proved counterproductive. </p>
<h2>Stimulus and the pandemic</h2>
<p>During the pandemic, the situation has been different. Central banks have again been trying to stimulate the economy by expanding QE, but governments have also been using debt-funded spending to substitute for the normal demand that has disappeared because of the shutdowns. </p>
<p>Major governments seem determined to correct the flawed policies of the past decade. This is especially true of the Biden administration, <a href="https://theconversation.com/joe-bidens-us-1-9-trillion-stimulus-wont-be-enough-to-reignite-world-economy-on-its-own-157252">whose</a> massive programme of increased spending aims to drive up labour participation and wages – thereby avoiding the deflationary troubles of the 2010s. </p>
<p>The administration is firmly supported in this by Federal Reserve chair Jerome Powell. In <a href="https://www.federalreserve.gov/monetarypolicy/review-of-monetary-policy-strategy-tools-and-communications-statement-on-longer-run-goals-monetary-policy-strategy.htm">August 2020</a>, the central bank changed its inflation policy to “<a href="https://www.cnbc.com/2020/08/27/powell-announces-new-fed-approach-to-inflation-that-could-keep-rates-lower-for-longer.html">average inflation targeting</a>”. Whereas in the past, the Fed targeted 2% inflation and would raise interest rates in response to low unemployment in the belief that inflation would otherwise start rising, it is now ready to allow inflation to rise to say 3% in the name of increasing employment to help stimulate economic recovery. </p>
<p>The success of this strategy depends on demand for more workers materialising from US businesses. But critics like <a href="https://www.bloomberg.com/news/articles/2021-03-20/summers-says-u-s-facing-worst-macroeconomic-policy-in-40-years">Larry Summers</a>, the former Democratic treasury secretary, argue that the government’s fiscal stimulus will create demand beyond the economy’s present production potential, risking persistent inflation. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/402892/original/file-20210526-19-1f8emdn.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Pound coin being squeezed in a vice" src="https://images.theconversation.com/files/402892/original/file-20210526-19-1f8emdn.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/402892/original/file-20210526-19-1f8emdn.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=448&fit=crop&dpr=1 600w, https://images.theconversation.com/files/402892/original/file-20210526-19-1f8emdn.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=448&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/402892/original/file-20210526-19-1f8emdn.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=448&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/402892/original/file-20210526-19-1f8emdn.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=563&fit=crop&dpr=1 754w, https://images.theconversation.com/files/402892/original/file-20210526-19-1f8emdn.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=563&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/402892/original/file-20210526-19-1f8emdn.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=563&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">The big squeezy.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/concept-financial-stress-recession-uk-one-1806387883">Steve Heap</a></span>
</figcaption>
</figure>
<p>The administration and its supporters counter that there is more slack in the economy than people like Summers believe, because so many discouraged workers have dropped out, and higher production of goods and services will result from reversing the <a href="https://www.ceicdata.com/en/indicator/united-states/investment--nominal-gdp">long dearth</a> of domestic business investment.</p>
<p>All such happy effects will, according to the plan, flow from using government spending to generate demand. The jury remains out on whether this will cause unmanageable inflation – either in America or, potentially, in Europe if the ECB, together with the EU and its member states, follow their <a href="https://www.reuters.com/article/us-france-economy-idUSKBN2BO5KF">apparent inclination</a> to emulate the US.</p>
<h2>A danger and an opportunity</h2>
<p>Returning to my own studies of the exit from the “great inflation” of the 1970s, two lessons emerge that should help the jury in its deliberations about where we go from here. One points to an opportunity, the other to a danger.</p>
<p>The first lesson has to do with confidence and the expectations of firms and households, which dominate any discussion about inflation. The 1970s inflation was only really subdued after central banks were given operational independence from politicians to pursue low and stable inflation. As monetary policy became more credible, people no longer expected prices to rise so fast. </p>
<p>This was the main reason for the flattening of the Phillips curve – that is, inflation no longer jumps up smartly as unemployment falls. Present-day policies to stimulate demand benefit from well anchored inflation expectations. Put bluntly, policymakers will “get away” with more stimulus before having to pay an inflationary price, and this should improve their chances of success.</p>
<p>A key figure in the development of such thinking about expectations in the 1970s-80s was the American economist Thomas Sargent. <a href="https://www.nobelprize.org/prizes/economic-sciences/2011/summary/">His work</a> on “systematic changes in inflation policy” also underlies the second – and more cautionary – lesson for today’s policymakers and the present inflation outlook. </p>
<p>This was crystallised in a 1982 paper by Sargent and Neil Wallace called <a href="https://www.minneapolisfed.org/research/quarterly-review/some-unpleasant-monetarist-arithmetic">Some Unpleasant Monetarist Arithmetic</a> showing that monetary and fiscal policy are inextricably intertwined. At the heart of this thinking sits the idea of a government’s budget constraint. If government spending stimulates demand to the extent of driving up inflation, and monetary policymakers then respond by raising interest rates, a nasty surprise can ensue. </p>
<p>Higher interest rates increase a government’s interest payments on its debt. If the government responds by issuing even more debt to finance its activities, it can make inflation rise even faster – as the government’s extra spending would end up driving up demand just as the central bank is trying to curb it. In other words, a government can only run so much of a deficit before unforeseen problems crop up. </p>
<p>Today this lesson is even more relevant than Sargent and Wallace could have imagined. Nowadays, interest rates can no longer be a central bank’s first instrument of monetary policy: <a href="https://tradingeconomics.com/united-kingdom/government-debt-to-gdp">public</a> and <a href="https://tradingeconomics.com/united-kingdom/private-debt-to-gdp">private debt</a> are so high that raising rates could potentially make repayments unmanageable for many. </p>
<p>To take the US as the most prominent example, the Fed would instead start out by cutting back the level of government bond purchases going on to its balance sheet. This bond purchasing has ballooned in the past decade, particularly since governments’ heavy deficit spending during the pandemic. </p>
<p>The problem is that the money created through QE ends up, for reasons that don’t need to be explained here, in the reserves of commercial banks held by the central bank. In the US, these sums <a href="https://www.federalreserve.gov/releases/h8/current/">now approach</a> a fifth of all of the Fed’s assets. </p>
<p>As and when the Fed decides to “taper” QE – <a href="https://fred.stlouisfed.org/series/WALCL">now running at</a> US$120 billion (£85 billion) of purchases per month – as a first step in tightening policy to lean against inflation, this will result in a lower proportion of banks’ assets being lodged with the Fed in the form of reserves, and increase the scope for banks to lend to the real economy. </p>
<p>Such credit expansion and the associated increase in the velocity of money is likely to fuel the inflation pressures that the Fed wants to counter. Since one of the main aims of QE is to increase bank lending, it’s a paradoxical effect – just like the previous example of higher interest rates increasing inflation. </p>
<p>The bottom line is that public debt has expanded to the extent of becoming unaffordable in a free market. Today’s conundrum created by QE is just the latest demonstration of the reality that disregarding government budget constraints will result, by one way or another, in higher inflation.</p>
<h2>Long-term trends</h2>
<p>The final question is how all of this relates to long-term trends in the labour market and elsewhere. It is often said that in the past couple of decades, globalisation and technology have both helped to reduce inflation. Globalisation has kept wages lower by moving production to poorer countries. Technology has made it cheaper to produce goods and therefore brought prices down, while the <a href="https://blogs.lse.ac.uk/netuf/2018/10/25/wages-in-the-gig-economy-and-beyond/">the gig economy</a> has reduced the cost of services. </p>
<p>But a <a href="https://www.palgrave.com/gp/book/9783030426569">recent book</a> by British-based economists Charles Goodhart and Manoj Pradhan <a href="https://blogs.lse.ac.uk/businessreview/2020/09/18/the-great-demographic-reversal-and-what-it-means-for-the-economy/">argues that</a> the years to come will be far less deflationary, for several reasons. China’s labour market participation is rising, which is increasing wages, and baby boomers are retiring, taking a very large generation out of the labour market and making workers more scarce and therefore more valuable. </p>
<p>It’s a fascinating argument, but <a href="https://www.wsj.com/articles/the-great-demographic-reversal-review-the-perils-of-aging-11607381251">still very debatable</a>. For example, possible inflationary effects of ageing populations might yet be outweighed by the deflationary effect of rapid technological change automating more jobs. This will reduce workers’ bargaining power and therefore act as a brake on wage growth. Also, most <a href="https://citywire.co.uk/funds-insider/news/forget-retirement-splurges-pensioners-are-hoarding-too-much/a864433">people consume less</a> in retirement, and certainly do not borrow as much: the ageing of the baby boomers will therefore be another source of deflation.</p>
<p>In sum, there is good reason to expect inflation in the short to medium term, but the longer term picture is more mixed. The seeds of higher long-term inflation are surely present, but the chances of their germinating will depend to a large extent on to what extent the extra fiscal stimulus from the US and elsewhere leads to increased production, as opposed to only consumption. </p>
<p>If there is higher business investment and labour participation, government budget deficits will narrow faster as the private sector gets back into gear and pays more in taxes. This will also help the Fed to find a smoother path through the minefield of the exit from QE, since the increased bank lending will be more likely to be unlocking sustainable economic growth. If so, it is still possible that the central banks’ claims that inflation will only be transitory could still be proven right.</p><img src="https://counter.theconversation.com/content/161461/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Brigitte Granville does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Debate is raging about whether the recent burst of inflation is temporary or here to stay.Brigitte Granville, Professor of international economics and economic policy, Queen Mary University of LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1596082021-04-23T11:55:11Z2021-04-23T11:55:11ZInflation: why it could surge after the pandemic<figure><img src="https://images.theconversation.com/files/396644/original/file-20210422-15-1qdtdha.png?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Not swell.</span> <span class="attribution"><span class="source">Nikvart/Shutterstock</span></span></figcaption></figure><p>Inflation is rising again in the UK, according to the Office for National Statistics. <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/march2021">Prices in March</a> rose 0.7% compared to a year earlier, against a 0.4% rise in February. One of the main drivers was that fuel prices have seen their biggest increase since January 2020.</p>
<p>This rise in inflation is <a href="https://www.reuters.com/world/uk/uk-inflation-rises-07-march-clothing-fuel-prices-grow-2021-04-21/">roughly in line</a> with what analysts were expecting. The Bank of England <a href="https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2021/february-2021#:%7E:text=The%20MPC%20voted%20unanimously%20to,reserves%2C%20at%20%C2%A320%20billion.">has been</a> expecting inflation to rise this spring as well, but thinks it will then settle down. </p>
<p>In my view, inflation will go much further than the Bank expects. The twin policies of creating new money, known as quantitative easing (QE), and extra government borrowing to pay for COVID support measures could lead to prices surging in the months ahead – with unsettling implications for the UK economy’s recovery from the pandemic. </p>
<p>The Bank has a duty to maintain consumer price inflation at 2%. Inflation measures how much prices for goods and services are rising – or the rate at which the pound is falling in purchasing power, therefore making goods more expensive. Since the pandemic began, inflation has undershot this target, as you can see from the graph below.</p>
<p><strong>UK annual inflation 2020-21</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/396631/original/file-20210422-22-10q58gs.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="UK inflation 2020-21" src="https://images.theconversation.com/files/396631/original/file-20210422-22-10q58gs.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/396631/original/file-20210422-22-10q58gs.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=302&fit=crop&dpr=1 600w, https://images.theconversation.com/files/396631/original/file-20210422-22-10q58gs.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=302&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/396631/original/file-20210422-22-10q58gs.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=302&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/396631/original/file-20210422-22-10q58gs.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=379&fit=crop&dpr=1 754w, https://images.theconversation.com/files/396631/original/file-20210422-22-10q58gs.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=379&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/396631/original/file-20210422-22-10q58gs.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=379&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/march2021">ONS</a></span>
</figcaption>
</figure>
<p>To understand where inflation might go next, it helps to compare the responses by the authorities to the pandemic and the financial crisis of 2007-09. After the financial crisis, the Bank of England and other central banks used QE to increase the amount of money in the economy (also known as the monetary base). They did this by using digitally created money to buy mostly short-term government bonds from investors such as banks and pension funds.</p>
<p>The aim was to stimulate growth and recovery, since increased demand for bonds pushes interest rates down and encourages people to borrow and to put more money into riskier assets like the stock market. The UK monetary base <a href="https://www.bis.org/publ/bppdf/bispap65p_rh.pdf">grew fourfold</a>, but only in the <a href="https://www.investopedia.com/terms/b/broad-money.asp">broadest sense</a> of money that includes things like pension funds and large bank deposits that can’t be accessed for a long period of time. On the other hand, the most common measure of money in the economy, <a href="https://www.investopedia.com/terms/m/m2.asp#:%7E:text=M2%20is%20a%20measure%20of,includes%20cash%20and%20checking%20deposits.">M2</a>, which is mainly cash and bank deposits, remained flat. </p>
<p>The reason for this difference is that much of the QE money ended up on bank balance sheets to shore up the amount of capital they have to protect themselves from bad debts and periods like 2007-09 when money does <a href="https://www.investopedia.com/terms/l/liquidity-crisis.asp">not circulate properly</a>. In other words, the banks didn’t lend much of the money to businesses and consumers so it didn’t reach the wider economy. This is why a fourfold expansion in money produced little inflation. </p>
<p><strong>UK inflation 1996-2021</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/396640/original/file-20210422-22-1fywunz.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="UK inflation over 25 years" src="https://images.theconversation.com/files/396640/original/file-20210422-22-1fywunz.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/396640/original/file-20210422-22-1fywunz.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=259&fit=crop&dpr=1 600w, https://images.theconversation.com/files/396640/original/file-20210422-22-1fywunz.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=259&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/396640/original/file-20210422-22-1fywunz.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=259&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/396640/original/file-20210422-22-1fywunz.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=326&fit=crop&dpr=1 754w, https://images.theconversation.com/files/396640/original/file-20210422-22-1fywunz.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=326&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/396640/original/file-20210422-22-1fywunz.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=326&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://tradingeconomics.com/united-kingdom/inflation-cpi">Trading Economics/ONS</a></span>
</figcaption>
</figure>
<p>At the time of this programme, the government was <a href="https://tradingeconomics.com/united-kingdom/government-budget">cutting back</a> spending to try and bring its deficit down. During the pandemic, it has been doing the opposite: raising money by issuing bonds to pay for the COVID furlough scheme and the various other support measures. </p>
<p>The Bank has been running its latest QE programme in tandem, potentially taking it <a href="https://www.bankofengland.co.uk/independent-evaluation-office/ieo-report-january-2021/ieo-evaluation-of-the-bank-of-englands-approach-to-quantitative-easing#:%7E:text=As%20of%20November%202020%2C%20the,20%20billion%20of%20corporate%20bonds.">to £895 billion</a> by the end of the year. This has kept interest rates low, which has enabled the government to borrow more cheaply. </p>
<p>Because of this monetary (central bank) and fiscal (government) stimulus, the effect on the money supply has been different. I estimate that the total monetary base <a href="https://www.bankofengland.co.uk/statistics/details/further-details-about-m4-data">has grown 50%</a> since March 2020, while M2 <a href="https://www.ceicdata.com/en/indicator/united-kingdom/money-supply-m2">has grown</a> by around 25%. This should create much more inflationary pressure than after 2007-09. </p>
<h2>How high?</h2>
<p>Like in the 2010s, today some of the extra money has been spent on speculative investments like the stock market – if speculative asset prices were included in CPI, it would be well over 2% already. But the rest is <a href="https://www.ft.com/content/76dc1ed6-a999-4b8d-9fff-25aadfe3b595">being sat on</a> by businesses and consumers, waiting for the COVID restrictions to be lifted. Of particular risk to prices is that this pent-up money leads to excessive demand before the supply of goods and services has returned to pre-pandemic levels. </p>
<p>The Bank <a href="https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2021/february-2021#:%7E:text=The%20MPC%20voted%20unanimously%20to,reserves%2C%20at%20%C2%A320%20billion.">thinks it</a> most likely that the pent-up demand will increase inflation to nearer 2% over the spring, and broadly keep it there into 2022 and 2023. However, its projections are actually much more uncertain than usual, despite claiming inflation is “<a href="https://www.ft.com/content/271a78c7-895a-45b6-92c3-e41cb3ed540f">well anchored</a>”.</p>
<p>When you look at the Bank’s more detailed projections, it sees a one in three chance of inflation below zero or above 4% over the next couple of years – in other words, it simply doesn’t know. You can see this in the fan graph below, which displays the central projection in the darkest shade and the least likely in the lightest. </p>
<p><strong>Bank of England inflation forecasts</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/396630/original/file-20210422-21-1lalrpo.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Bank of England inflation forecasts" src="https://images.theconversation.com/files/396630/original/file-20210422-21-1lalrpo.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/396630/original/file-20210422-21-1lalrpo.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=380&fit=crop&dpr=1 600w, https://images.theconversation.com/files/396630/original/file-20210422-21-1lalrpo.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=380&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/396630/original/file-20210422-21-1lalrpo.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=380&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/396630/original/file-20210422-21-1lalrpo.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=477&fit=crop&dpr=1 754w, https://images.theconversation.com/files/396630/original/file-20210422-21-1lalrpo.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=477&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/396630/original/file-20210422-21-1lalrpo.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=477&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><span class="source">Bank of England</span></span>
</figcaption>
</figure>
<p>The Bank’s <a href="https://www.thetimes.co.uk/article/bank-of-england-chief-economist-andy-haldane-quits-to-head-the-rsa-think-tank-v93t7xnz0#:%7E:text=Andy%20Haldane%2C%20who%20was%20overlooked,Manufactures%20and%20Commerce%20(RSA).">outgoing</a> chief economist, Andy Haldane, has <a href="https://www.bankofengland.co.uk/speech/2021/february/andy-haldane-recorded-mini-speech-on-inflation-outlook">said that</a> QE has left the UK and other countries in “deep and uncharted waters”. Haldane believes the long-term effects of the pandemic recession are likely to be towards the top end of expectations. If so, the Bank’s inflation forecasts are likely to be too low. </p>
<p>Economists, and more specifically monetarists, fear that the Bank is underestimating the effects of inflation. These people are likely to be correct, since increasing M2 has <a href="https://www.economicshelp.org/blog/111/inflation/money-supply-inflation/">always led</a> to inflationary pressure in the past.</p>
<p>It may be a fool’s errand to predict future inflation, but there is genuine reason to believe it could surge past its 2% target to rise beyond 4% by the second half of 2022. By then, the government may be helping to curb it by reining in spending and raising taxes, both of which would reduce the money supply. </p>
<p>But mainly it would fall to the Bank to raise interest rates to stop consumers from spending to the same extent (while presumably also insisting the extra inflation was outwith its control and not due to QE or the fiscal stimulus). This would cause economic contraction and cause <a href="https://www.statista.com/chart/24023/corporate-debt-level-by-country/">businesses</a> and <a href="https://tradingeconomics.com/united-kingdom/households-debt-to-gdp">consumers</a> to struggle with debts that are already at very high levels. </p>
<p>In other words, we could be looking at an old-fashioned boom and bust phase of expansion and contraction within the next 18 months, and more challenging times ahead as a result. Much may depend on coronavirus in Europe and whether a new wave arrives, since this could potentially choke off the recovery and keep inflation under wraps.</p><img src="https://counter.theconversation.com/content/159608/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Ian Crowther does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>When you study the money supply, it shows that the inflation risk is different than in the 2010s.Ian Crowther, Senior Lecturer in Banking and Financial Markets, Sheffield Hallam UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1404062020-06-11T11:50:49Z2020-06-11T11:50:49ZPaying for coronavirus will have to be like war debt – spread over generations<figure><img src="https://images.theconversation.com/files/341145/original/file-20200611-80770-x07k17.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">All this costs money. </span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/financial-war-concept-currency-dollar-euro-1733446778">Swiss Stock Photo</a></span></figcaption></figure><p>The macroeconomic shock to the world economy from the COVID-19 pandemic is arguably unprecedented in modern times. The financial response by governments of the major economies has been substantial. </p>
<p>The Center for Strategic and International Studies <a href="https://www.csis.org/analysis/breaking-down-g20-covid-19-fiscal-response-may-2020-update">estimates that</a> the G20 had deployed US$7 trillion (£6.2 trillion) in direct spending, tax relief and lending by the end of May. That is more than 10% of their combined GDP for 2019, averaging over 12% among the advanced economies. This exceeds the fiscal support measures taken by governments during the great financial crisis of 2007-09, as can be seen in the map below. </p>
<p><strong>Fiscal interventions COVID-19 vs great financial crisis</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/340947/original/file-20200610-34670-l05ktb.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/340947/original/file-20200610-34670-l05ktb.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/340947/original/file-20200610-34670-l05ktb.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=301&fit=crop&dpr=1 600w, https://images.theconversation.com/files/340947/original/file-20200610-34670-l05ktb.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=301&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/340947/original/file-20200610-34670-l05ktb.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=301&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/340947/original/file-20200610-34670-l05ktb.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=379&fit=crop&dpr=1 754w, https://images.theconversation.com/files/340947/original/file-20200610-34670-l05ktb.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=379&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/340947/original/file-20200610-34670-l05ktb.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=379&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.atlanticcouncil.org/blogs/econographics/how-does-the-g20-covid-19-fiscal-response-compare-to-the-global-financial-crisis/">Atlantic Council</a></span>
</figcaption>
</figure>
<p>Yet economists agree that 2020’s interventions were both necessary and timely. More may also be needed. In many of the industrialised economies, governments have focused on employment support and subsidised loans to businesses of all sizes. Some countries like Germany <a href="https://edition.cnn.com/2020/06/04/business/germany-stimulus-electric-cars/index.html">are now announcing</a> major investments in green infrastructure and consumer incentives like cutting VAT and subsidies for electric and hybrid vehicles. </p>
<h2>Debt and more debt</h2>
<p>In the UK, the Office for Budget Responsibility (OBR) currently <a href="https://obr.uk/coronavirus-analysis/">estimates that</a> the total impact on government borrowing will be £132.5 billion in 2020-21. This will widen the deficit to over 15% of GDP, <a href="https://tradingeconomics.com/united-kingdom/government-budget">compared to</a> less than 2% in 2018-19. </p>
<p>Even this depends on whether the lockdowns end and economic activity can resume. If not, deficits <a href="https://voxeu.org/article/fiscal-costs-lockdown-three-scenarios-uk">could exceed</a> those seen in wartime, <a href="https://theconversation.com/coronavirus-will-drive-public-debt-far-higher-than-expected-but-that-doesnt-mean-a-return-to-austerity-136295">when they peaked</a> in the regions of 25%-30% of GDP.</p>
<p>Many wonder how the additional debt will be paid for. For the UK, even on the OBR’s most optimistic scenario that economic activity will rapidly recover in the three months following a three-month lockdown, the debt-to-GDP ratio peaks at 110% and returns to 95% in 2021. If the recovery is much slower, most governments will face very high debt-to-GDP ratios indeed. </p>
<p>Like in the great financial crisis, central banks are playing an important role in the market for government debt with major quantitative easing (QE) programmes. QE involves central banks creating new money to buy assets – mostly government debt in the form of sovereign bonds, and sometimes also commercial debt. </p>
<p>On March 19, the Bank of England <a href="https://www.bankofengland.co.uk/markets/market-notices/2020/apf-asset-purchases-and-tfsme-march-2020">said it would</a> increase its holdings of UK government bonds (gilts) and certain corporate bonds by £200 billion to £645 billion. The ECB <a href="https://www.ecb.europa.eu/press/pr/date/2020/html/ecb.pr200318_1%7E3949d6f266.en.html">announced</a> a €750 billion (£668 billion) programme around the same time, then <a href="https://www.ecb.europa.eu/press/pr/date/2020/html/ecb.mp200604%7Ea307d3429c.en.html">expanded it</a> on June 4 to €1.35 trillion. The Fed’s new QE commitment is open-ended, <a href="https://www.federalreserve.gov/releases/h41/">with over</a> US$1.5 trillion of assets purchased since the crisis began. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/340907/original/file-20200610-34682-1uswqb4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/340907/original/file-20200610-34682-1uswqb4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/340907/original/file-20200610-34682-1uswqb4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=450&fit=crop&dpr=1 600w, https://images.theconversation.com/files/340907/original/file-20200610-34682-1uswqb4.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=450&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/340907/original/file-20200610-34682-1uswqb4.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=450&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/340907/original/file-20200610-34682-1uswqb4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=566&fit=crop&dpr=1 754w, https://images.theconversation.com/files/340907/original/file-20200610-34682-1uswqb4.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=566&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/340907/original/file-20200610-34682-1uswqb4.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=566&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">‘Keep 'em rolling.’</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-illustration/money-printing-machine-100-dollar-banknotes-1699710331">cigdem</a></span>
</figcaption>
</figure>
<p>It’s important to note that QE programmes are not directly financing government spending. The money created by the central banks is used to buy government debt from the likes of investment funds which have bought it from the government. The central banks are propping up demand for this debt to ensure that the cost of government borrowing stays low. This potentially avoids disorderly situations where investors become more wary of buying the debt because they think that the country in question has become a bigger credit risk. </p>
<p>QE also supports economic recovery through other channels. First, when central banks put new money into government and corporate debt, it encourages investors to redirect their money into relatively similar assets like shares or different corporate debt. </p>
<p>This is known as the portfolio rebalancing effect, and it brings benefits. For instance, if extra demand causes the price of certain shares or corporate debt to increase, the cost of borrowing for the companies in question will fall. This lowers the cost of borrowing across the economy. </p>
<p>Second, the purchase of government debt from banks gives them more money to potentially lend. This is reversed when the QE programme ends. Third, the asset purchases create stability. During the great financial crisis, one of the greatest impacts of QE was to signal to financial markets that the central banks were serious about sustaining economic recovery with a loose monetary policy that kept interest rates low. </p>
<h2>Risks and consequences</h2>
<p>The key question about QE is whether giving governments breathing space to borrow, while loosening monetary policy, will have unforeseen consequences. After the 2007-09 crisis, there were concerns that QE would drive up asset prices and cause people to take excessive risks. There <a href="https://www.aeaweb.org/forum/311/have-low-interest-rates-led-to-excessive-risk-taking">is evidence</a> that this did happen. </p>
<p>This time around, we have already seen stock markets surging. The S&P 500 <a href="https://www.bbc.co.uk/news/topics/c4dldd02yp3t/sp-500">is up</a> 43% since mid-March. Linked to this are concerns that unwinding a very large QE programme at the end of the crisis could destabilise markets – note that the QE injections following the previous crisis have <a href="https://theconversation.com/quantitative-easing-now-looks-permanent-and-has-turned-central-banks-into-pseudo-governments-130098">never been</a> completely reversed. </p>
<p>Another worry is that QE may be insufficient to stimulate demand in the economy after a crisis as deep as that caused by COVID-19. Some economists, such as <a href="https://voxeu.org/article/helicopter-money-time-now">Jordi Gali</a> and <a href="https://voxeu.org/article/funding-pandemic-relief-monetise-now">Refet Gürkaynak and Deborah Lucas</a>, are arguing for a so-called “helicopter drop” of money to support fiscal policy. </p>
<p>What they mean is central banks giving new money direct to their governments that would never need to be repaid – known as direct monetary financing. This would remove the need for those governments to issue extra debt to the markets. </p>
<p>It’s probably too early to resort to such financing, without seeing how long the crisis lasts and how effective QE is in supporting governments in debt financing. Meantime, more could be done to spread the debt burden across several generations. </p>
<p>For example, governments could issue debt with very long maturity dates like 50 or 100 years, or even debt that never matures – so-called perpetual debt or consols – as is common in war-time finance. The UK chancellor, Rishi Sunak, is <a href="https://www.aljazeera.com/ajimpact/decades-debt-uk-finance-chief-told-gradual-pay-offs-200610065825500.html">currently being urged</a> by many in his party to think along these lines. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/340912/original/file-20200610-34705-1usevpq.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/340912/original/file-20200610-34705-1usevpq.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/340912/original/file-20200610-34705-1usevpq.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/340912/original/file-20200610-34705-1usevpq.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/340912/original/file-20200610-34705-1usevpq.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/340912/original/file-20200610-34705-1usevpq.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/340912/original/file-20200610-34705-1usevpq.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/340912/original/file-20200610-34705-1usevpq.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">UK Chancellor Rishi Sunak.</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/hmtreasury/49890146467/in/photolist-2j1C3p6-2j4iDqH-2j1jDEY-2j1C3oe-2iCav8c-2iD9hiM-2iR1ysQ-2iF8KJZ-2iFeTDt-2iG843M-2iSwsZt-2iSwkYK-2iSs232-2iQi1yB-2iNcSk9-2iNhiKt-2iSrMN6-2iQn5ND-2iQhNVG-2iQkwwM-2iNfCcG-2iSwjNZ-2iNhiM7-2iSrTcn-2iNcSoa-2iSwhan-2iNhfF2-2iNcSpC-2iNfCk7-2iNfCo8-2iNfCgp-2iAhcys-2j1C3t9-2iAhemL-2iR1vkC-2j6QDKS-2iD8mB8-2iC6pjH-2iAfSmv-2j6MjD8-2iUZAAK-2iCS7gx-2j6PUrc-2iUVexS-2iR4gwC-2iBkbCD-2iR49FP-2j6QDT2-2j6R9bA-2itt9qT">HM Treasury</a>, <a class="license" href="http://creativecommons.org/licenses/by-sa/4.0/">CC BY-SA</a></span>
</figcaption>
</figure>
<p>It is also important to realise that direct monetary financing is not a free lunch. </p>
<p>Regrettably, there is no magic money tree in economics. Ultimately current government spending is a claim on real resources that has to be financed either directly through future taxes and growth or lower future spending, or through future inflation (which is a tax on money and creditors).</p>
<p>The crisis will, however, mark a change in the relationship between governments and central banks. Blurring the boundaries between the two, even through QE, requires them to co-ordinate their actions much more closely. In the post-COVID era, the notion that central banks are independent of governments is bound to be somewhat diminished.</p><img src="https://counter.theconversation.com/content/140406/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Anton Muscatelli does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>There is no magic money tree in economics – whatever money is spent must be paid back later.Anton Muscatelli, Principal and Vice Chancellor, University of GlasgowLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1338842020-03-17T14:32:26Z2020-03-17T14:32:26ZCoronavirus: five essential measures to bolster the global central bank ‘bazooka’<figure><img src="https://images.theconversation.com/files/321058/original/file-20200317-60871-s6ex72.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">No signs of the bottom. </span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/close-human-figure-sitting-near-red-1063382042">Andrey_Popov</a></span></figcaption></figure><p>As the coronavirus escalates and public worries about the outbreak <a href="https://trends.google.com/trends/explore?date=today%203-m&q=%2Fm%2F01cpyy">sky-rocket worldwide</a>, the <a href="https://www.ft.com/content/be732afe-6526-11ea-a6cd-df28cc3c6a68">attempts by</a> central banks to unleash a co-ordinated response have fallen alarmingly flat. </p>
<p>America’s central bank, the Federal Reserve, led the way on March 15 by <a href="https://www.ft.com/content/a9a28bc0-66fb-11ea-a3c9-1fe6fedcca75">slashing the</a> US headline interest rate to zero (between 0% and 0.25%) and <a href="https://www.zerohedge.com/markets/fed-panics-powell-cuts-rates-zero-announces-700bn-qe5-unveils-enhanced-global-swap-lines">launching a</a> new US$750 billion (£620 billion) round of quantitative easing (QE), the policy that aims to shore up the financial system by creating new money to buy assets like government bonds. This supposed “bazooka” came less than two weeks after the Fed <a href="https://www.nytimes.com/2020/03/03/business/economy/fed-rate-cut.html">cut rates</a> from 1.75% to 1.25% and <a href="https://theweek.com/articles/901853/feds-15-trillion-intervention-explained">subsequently made</a> US$1.5 trillion in additional liquidity available to US banks. </p>
<p>The Bank of Japan, which has been pursuing QE continuously for a decade, has announced it will double its programme for buying stocks to ¥12 trillion (£93 billion) a year, while also increasing its purchases of shares in property funds and corporate bonds. These followed <a href="https://theconversation.com/budget-2020-new-uk-chancellor-unveils-30-billion-coronavirus-fightback-but-debt-forecasts-look-optimistic-133461">comparable moves</a> by the Bank of England, <a href="https://ftalphaville.ft.com/2020/03/13/1584112356000/The-eurozone-s-response--digested/">European Central Bank</a> and most recently the <a href="http://www.xinhuanet.com/english/2020-03/16/c_138882657.htm">People’s Bank of China</a>. </p>
<p>World markets were <a href="https://www.bbc.co.uk/news/business/market-data">deeply unimpressed</a> by this huge intervention. The Dow Jones plunged 13% on Monday March 16, its <a href="https://www.cnbc.com/2020/03/16/us-stock-futures-rise-slightly-following-dows-third-worst-day-ever.html">second worst ever</a> daily performance after the Black Monday crash of 1987, and many markets are falling again on March 17. During previous crises, such coordinated moves <a href="https://www.nytimes.com/2020/03/03/business/economy/fed-rate-cut.html">have seen</a> markets rise or at least stop falling so sharply. </p>
<h2>Policy limits</h2>
<p>Part of the problem, as outlined <a href="https://academic.oup.com/oxrep/article-abstract/28/4/750/343730">in research</a> I co-authored with Chris Martin, a professor at the University of Bath, is that QE is fairly ineffective in the current environment of extremely low interest rates. Notably, both the UK and US governments’ costs of borrowing for ten years <a href="https://www.bloomberg.com/markets/rates-bonds/government-bonds/uk">are</a> extremely low. This means that injecting more QE in an attempt to lower the country-specific costs of borrowing, which is in turn intended to pass through to lower corporate borrowing, has just about reached its limits. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/the-fed-will-have-to-do-a-lot-more-than-cut-rates-to-zero-to-stop-wall-streets-coronavirus-panic-133739">The Fed will have to do a lot more than cut rates to zero to stop Wall Street's coronavirus panic</a>
</strong>
</em>
</p>
<hr>
<p>It has not helped that ECB president Christine Lagarde <a href="https://ftalphaville.ft.com/2020/03/12/1584027114000/A-dangerous-slip-up-from-Lagarde/">made a “dangerous slip”</a> a few days ago when she said it wasn’t the bank’s job to narrow the differences in borrowing costs between different eurozone countries. She was comparing Germany and Italy, in a statement that seemed totally at odds with her predecessor Mario Draghi’s loud commitment to do “<a href="https://www.ecb.europa.eu/press/key/date/2012/html/sp120726.en.html">whatever it takes</a>” to prop up the struggling Mediterranean countries during the eurozone crisis in order to save the euro. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/321053/original/file-20200317-60915-nabjx2.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/321053/original/file-20200317-60915-nabjx2.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/321053/original/file-20200317-60915-nabjx2.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/321053/original/file-20200317-60915-nabjx2.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/321053/original/file-20200317-60915-nabjx2.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/321053/original/file-20200317-60915-nabjx2.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/321053/original/file-20200317-60915-nabjx2.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/321053/original/file-20200317-60915-nabjx2.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Christine Lagarde: gaffeing in the face of adversity.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/managing-director-imfchristine-lagarde-gives-press-1053383321">Alexandros Michailidis</a></span>
</figcaption>
</figure>
<p>Though Lagarde and her <a href="https://www.rte.ie/news/business/2020/0313/1122064-ecbs-lane-on-bond-spreads/">chief economist</a> later <a href="https://www.cnbc.com/2020/03/12/ecbs-lagarde-walks-back-comments-which-caused-italian-bond-yields-to-spike.html">clarified that</a> the ECB would fight against fragmentation in the eurozone, the costs of borrowing for Greece and Italy <a href="http://www.ekathimerini.com/250398/article/ekathimerini/business/italian-and-greek-bond-yields-soar">have risen sharply</a>. As well as inflicting further jeopardy on these countries at a time when the coronavirus is causing chaos in Italy, many northern European banks are significantly exposed to Italian private and public debt – per the graph below. </p>
<p>Interestingly, after Draghi’s original “whatever it takes” statement in 2012, almost all European banks, particularly Portuguese ones, increased their exposure to Italian debt. French banks have maintained significant exposure ever since, while Greek banks should also worry because they have become more exposed in the past three years or so. </p>
<p><strong>Exposure to Italian debt as a % of total global debt exposure</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/321041/original/file-20200317-60889-q47czs.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/321041/original/file-20200317-60889-q47czs.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/321041/original/file-20200317-60889-q47czs.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=266&fit=crop&dpr=1 600w, https://images.theconversation.com/files/321041/original/file-20200317-60889-q47czs.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=266&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/321041/original/file-20200317-60889-q47czs.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=266&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/321041/original/file-20200317-60889-q47czs.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=335&fit=crop&dpr=1 754w, https://images.theconversation.com/files/321041/original/file-20200317-60889-q47czs.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=335&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/321041/original/file-20200317-60889-q47czs.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=335&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Source: Bank of International Settlements.</span>
</figcaption>
</figure>
<p>Mark Carney, the former governor of the Bank of England, <a href="https://news.sky.com/video/mark-carney-says-the-financial-system-is-part-of-the-solution-to-coronavirus-problem-11955156">recently mentioned that</a> banks, unlike during the 2008 financial crisis, can be “part of the solution” this time around, having been strengthened to cope with crises. To some extent, this may be right. But if Italy is not supported by the ECB, Europe’s banks will start to have a problem. </p>
<h2>What next</h2>
<p>To mitigate this crisis, there are five things that can now be done to help. </p>
<p>1) Governments must hammer together a <a href="https://www.imf.org/external/pubs/ft/wp/2002/wp02208.pdf">co-ordinated plan</a> to boost spending. This is <a href="https://www.ecb.europa.eu/pub/pdf/other/mb200903_focus07.en.pdf">likely to</a> be more effective than tax cuts in stimulating the economy in the short run. Such moves should build on the interventions we have seen from the <a href="https://theconversation.com/budget-2020-new-uk-chancellor-unveils-30-billion-coronavirus-fightback-but-debt-forecasts-look-optimistic-133461">likes of the UK</a> and <a href="https://www.usnews.com/news/business/articles/2020-03-16/new-zealand-announces-economic-stimulus-equal-to-4-of-gdp">New Zealand</a> already. Co-ordination is important, <a href="https://www.bloomberg.com/news/articles/2020-02-14/imf-chief-says-virus-might-warrant-coordinated-economic-response">as echoed</a> by the head of the IMF, because countries trade with each other. If one does “enough” to restore its supply chain and demand but others don’t, we will all still be stuck with the problems in supply and demand that are driving the economy down. </p>
<p>For instance, governments can support those who have lost their jobs or are quarantined. This is arguably more pressing in the UK, where unemployment benefits <a href="https://data.oecd.org/benwage/benefits-in-unemployment-share-of-previous-income.htm">are much lower</a> as a percentage of previous income than the OECD average. Another good move would be to increase wages for those on the front line, such as nurses, whose starting salaries <a href="https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/819464/NHSPRB_2019_Report_Web_Accessible__1_.pdf">took a hit</a> in real terms after the last financial crisis. </p>
<p>2) Tax cuts are still an important stimulus in the medium term, so we need to see them too. We should <a href="https://www.oecd.org/tax/tax-policy/tax-database/">significantly cut</a> VAT to stimulate consumer demand around the world, with particularly aggressive cuts from countries hit hardest by the outbreak. Governments should slash <a href="https://stats.oecd.org/Index.aspx?QueryId=78166">corporate tax rates</a> to help prevent companies from collapsing under the weight of the crisis. The <a href="https://www.oecd.org/tax/tax-policy/tax-database/">OECD average</a> VAT rate is 19.3% and the average corporate tax rate is 23.5%. If every country slashed both rates by five percentage points, it should help. </p>
<p>3) Closing European borders is not the answer. To see Germany, the power engine on the continent, <a href="https://www.bbc.co.uk/news/world-europe-51905129">doing this</a> for all but commercial traffic feels like a large step in the wrong direction. It risks introducing extra frictions in trade that will add to the economic downturn. This will make it harder to coordinate economic action and must be reversed. To <a href="https://www.theguardian.com/books/2008/jun/09/dantealighieri">misquote Dante</a>, the darkest places in the economic hell will be reserved for those who refuse to coordinate policies with other countries at a time like this. </p>
<p>4) To mitigate the mounting crisis in Europe, Christine Lagarde must keep re-iterating that her policy is a continuation of Draghi’s policy. This will re-assure the markets, which have a very short memory and like it when policymakers repeat robust messages.</p>
<p>5) While the virus is still rampant, there is a limit to what can be achieved by cutting taxes and interest rates. Only by getting it under control will we see the confidence boost that will bring consumers back to spending and allow healthy workers to return to full capacity. It goes without saying that this means implementing the best mitigation measures and pushing to create a vaccine as quickly as possible.</p><img src="https://counter.theconversation.com/content/133884/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Costas Milas received ESRC funding in the past which related to an ESRC Seminar Series on Nonlinearities in Economics and Finance</span></em></p>Markets normally rally when central banks throw trillions of dollars at a problem. But not this time.Costas Milas, Professor of Finance, University of LiverpoolLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1307182020-01-28T16:25:27Z2020-01-28T16:25:27ZNegative interest rates will not fix the global economy – just ask Switzerland<figure><img src="https://images.theconversation.com/files/312286/original/file-20200128-81357-476m9d.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Below ground level. </span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-illustration/switzerland-flag-background-1197476725">Andamati</a></span></figcaption></figure><p>Would you deposit one pound with a bank today if it was going to give you back less than one pound tomorrow? Simple rationality suggests that the answer is no. We are all used to positive interest rates where, say, if the rate is 2% per annum and we put in £100, we’ll receive £102 at the end of the year. </p>
<p>Yet base interest rates have actually been negative in Switzerland, Denmark, Japan and the eurozone for a number of years. This represents a new macroeconomic policy experiment primarily designed to stimulate economic activity: a logical extension of the way that central banks usually cut rates when growth falls away. If negative rates have tended to go unnoticed by many people, it’s only because the rates have generally only been imposed by central banks on the retail banks in their area, and not on most high-street customers. </p>
<p>Negative rates started in 2012 <a href="https://www.weforum.org/agenda/2016/11/negative-interest-rates-absolutely-everything-you-need-to-know/">with Denmark</a>, and over the next four years the other jurisdictions joined in – along with Sweden, which became the only one so far to <a href="https://tradingeconomics.com/sweden/interest-rate">raise rates</a> back up to 0% late last year. With global growth <a href="https://theconversation.com/buckle-up-for-turbulence-why-a-global-debt-crisis-looks-very-hard-to-avoid-127260">still lacklustre</a>, many believe that other countries may follow suit: US president, Donald Trump, <a href="https://markets.businessinsider.com/news/stocks/negative-interest-rates-explained-what-they-are-why-they-matter-2019-8-1028516867">called on</a> the US Federal Reserve to take rates negative, for instance. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/312287/original/file-20200128-81341-1di74wt.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/312287/original/file-20200128-81341-1di74wt.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/312287/original/file-20200128-81341-1di74wt.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=424&fit=crop&dpr=1 600w, https://images.theconversation.com/files/312287/original/file-20200128-81341-1di74wt.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=424&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/312287/original/file-20200128-81341-1di74wt.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=424&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/312287/original/file-20200128-81341-1di74wt.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=533&fit=crop&dpr=1 754w, https://images.theconversation.com/files/312287/original/file-20200128-81341-1di74wt.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=533&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/312287/original/file-20200128-81341-1di74wt.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=533&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">The sub club.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-vector/realistic-submarine-sun-glare-under-water-1263499933">Tikofff1</a></span>
</figcaption>
</figure>
<p>Switzerland and Denmark have gone furthest into negative territory, both offering unprecedentedly low rates of -0.75%. The Swiss National Bank, which has kept its rate at this level since 2015, <a href="https://www.ft.com/content/67f75b4c-fbe9-11e9-a354-36acbbb0d9b6">signalled recently</a> that it intends to stick with this experiment and is not ruling out going even more negative. It <a href="https://www.ipe.com/swiss-central-bank-sticking-with-negative-rates-in-pension-funds-interest/10034293.article">has said that</a> negative rates were boosting the economy and that the country’s fundamentals were not being significantly affected. </p>
<p>Not everyone agrees on what “not significant” means. Some commentators argue that the policy <a href="https://www.ft.com/content/67f75b4c-fbe9-11e9-a354-36acbbb0d9b6">has been very damaging</a> to the country. So who is right, and what can be learned?</p>
<h2>The plan</h2>
<p>The base interest rate set by a central bank plays a dual role. It influences people’s decisions on whether to save or invest their money – broadly speaking, people tend to save more when rates are higher and to invest and spend more when it’s cheaper to borrow. At the same time, interest rates influence a country’s exchange rate. The higher the interest rate, the higher the value of the currency. </p>
<p>Central banks in smaller economies such as Switzerland and Denmark introduced negative interest rates both to encourage people to spend more and because bigger players like the US and eurozone were experimenting with another unconventional monetary policy: <a href="https://theconversation.com/quantitative-easing-now-looks-permanent-and-has-turned-central-banks-into-pseudo-governments-130098">quantitative easing</a>. </p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/312291/original/file-20200128-81411-63nfn2.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/312291/original/file-20200128-81411-63nfn2.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/312291/original/file-20200128-81411-63nfn2.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=704&fit=crop&dpr=1 600w, https://images.theconversation.com/files/312291/original/file-20200128-81411-63nfn2.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=704&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/312291/original/file-20200128-81411-63nfn2.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=704&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/312291/original/file-20200128-81411-63nfn2.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=884&fit=crop&dpr=1 754w, https://images.theconversation.com/files/312291/original/file-20200128-81411-63nfn2.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=884&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/312291/original/file-20200128-81411-63nfn2.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=884&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Cuckoo?</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/emilywaltonjones/4010048580/in/photolist-77mxJC-wgXGCJ-6jUeaM-61iDxX-VM7p7Q-61nPo7-b6pvTv-bakF8H-itshuN-2W3a9S-aEDMgY-bakEQH-bakFJZ-TPFKNN-5xGCRr-eAjm-noKXq-paTpWf-CKvihB-9hqf7D-8TTiR6-pGMhzG-9kMrhZ-icJBh-bakG1V-HCzEfF-4sh98v-5pM7Mb-9TZLv3-cgjadA-5V8XRH-DFGiT2-31XibG-4VZhub-ffS9pb-8YYiDa-fjZX1-21yrBF3-7kxNr-2icEq2i-TPFKQw-dDGiYz-341vtX-kDynGK-kDyRTH-dutyiB-qCSQZd-9JjEW9-eHaCZt-7mPn71">Emily McCraken</a>, <a class="license" href="http://creativecommons.org/licenses/by-sa/4.0/">CC BY-SA</a></span>
</figcaption>
</figure>
<p>This policy was increasing the amount of dollars and euros in circulation, which pushed down the exchange rates on these currencies. This encouraged forex traders to buy the likes of the Swiss franc instead, driving up its price. Since a stronger Swiss franc would potentially hamper the country’s exports, negative interest rates were a way of pinning back the value of the franc. </p>
<p>Incidentally, not all central banks implemented negative interest rates for this reason. The European Central Bank’s decision was for the same reasons as it pursued quantitative easing: to avoid <a href="https://www.telegraph.co.uk/finance/financialcrisis/11002498/Eurozone-falls-further-towards-deflation-trap.html">getting sucked into</a> a deflationary spiral, in which people develop a mindset where they think the price of goods is going to keep falling so they decide it is better to hang on to their money than spend it. This would risk grinding economic activity to a halt. </p>
<h2>Outcomes</h2>
<p><a href="https://books.google.co.uk/books?id=cKDDDwAAQBAJ&pg=PA42&lpg=PA42&dq=negative+profits+switzerland&source=bl&ots=BVYKH1Kd1A&sig=ACfU3U2uX-7giXwZsXKDGLAYYx0hZCIzGw&hl=en&sa=X&ved=2ahUKEwixrIG5qqbnAhXQTxUIHXhhDr8Q6AEwEXoECAoQAQ#v=onepage&q=negative%20profits%20switzerland&f=false">In practice</a>, making rates negative has caused a problem in Switzerland – and much of what follows is true in Denmark as well. The banks know that if they went so far as to charge the average customer for depositing money, customers would simply withdraw en masse. This would wreck the whole banking business model by reducing working capital and causing severe funding problems. So the Swiss deposit rate for ordinary customers <a href="https://www.moneyland.ch/en/savings-accounts-international-comparison">is now around</a> a maximum of about 0.25%. </p>
<p>Banks have therefore had to absorb the charges they are paying themselves to deposit their own money with the central bank every day, where in times of positive interest rates they would be earning interest. Banks usually make money on the difference or “spread” between what they pay customers in interest for deposits or savings and what they charge in interest for loans. To minimise the damage to their profits, the retail banks have been unwilling to cut their lending rates to customers beyond a certain level – the average lending interest rate in Switzerland <a href="https://tradingeconomics.com/switzerland/lending-interest-rate-percent-wb-data.html">is at just over 2.6%</a>, for instance. </p>
<p>So what the experiment has shown is that once the deposit rate reaches the lowest that banks are willing to go, a central bank can’t further reduce the base rate into negative territory to encourage cheaper lending. In other words, further reductions become ineffective at stimulating the economy. </p>
<p>The retail banks have had to live with reduced profits in this environment – despite <a href="https://www.swissinfo.ch/eng/swiss-financial-marketplace_even-with-negative-interest-rates--swiss-banks-post-positive-results/45211400">performing relatively well</a> under the circumstances. There is also <a href="https://www.ft.com/content/a730ce84-f95e-11e9-98fd-4d6c20050229">pressure</a> on the country’s <a href="https://www.ipe.com/swiss-pension-bodies-increasingly-concerned-about-negative-rates/10033391.article">pensions industry</a>, since negative interest rates have also helped to turn bond yields negative, which affects how much they can pay to pensioners in benefits. </p>
<p>As a way of mitigating these difficulties, the banks and pension funds have sought riskier investments than usual for their spare capital. In particular, this has driven up the amount of money invested in real estate. <a href="https://www.bloomberg.com/news/articles/2019-03-19/world-s-lowest-interest-rate-brews-trouble-for-swiss-property">Property prices</a> have <a href="https://www.swissinfo.ch/eng/million-dollar-home_steep-increase-in-swiss-housing-prices-in-last-decade/44477772">overheated</a>, taking Switzerland <a href="https://lenews.ch/2019/10/11/zurich-homes-market-in-highly-overvalued-territory/">to the brink</a> of a housing crisis. To try and defuse this, Swiss lending rates on fixed ten-year mortgages <a href="https://en.comparis.ch/hypotheken/hypothek/analyse/hypobarometer">are now edging upwards</a> – notwithstanding the negative base rate. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/312288/original/file-20200128-81403-1nlxvf0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/312288/original/file-20200128-81403-1nlxvf0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/312288/original/file-20200128-81403-1nlxvf0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/312288/original/file-20200128-81403-1nlxvf0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/312288/original/file-20200128-81403-1nlxvf0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/312288/original/file-20200128-81403-1nlxvf0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/312288/original/file-20200128-81403-1nlxvf0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/312288/original/file-20200128-81403-1nlxvf0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Property prices have gone crazy in places like Zurich.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/zurich-switzerland-april-28-2018-street-1452973094">Viktor Jiang</a></span>
</figcaption>
</figure>
<p>In sum, the whole financial system in Switzerland looks more fragile than before. The Swiss National Bank argues negative rates <a href="https://www.ft.com/content/67f75b4c-fbe9-11e9-a354-36acbbb0d9b6">have been successful</a> because they have kept a lid on the Swiss franc, but the country is certainly paying a price. </p>
<p>And until now, public opinion has been somewhat muted because rates have not been passed on to the average bank customer. Yet there are <a href="https://money.cnn.com/2016/06/16/news/economy/negative-interest-rates-europe/">mounting concerns</a> both in Switzerland and in other countries about how people’s pension benefits are <a href="https://october.eu/dutch-consumer-worried-about-negative-interest-rates/">being affected</a>, and the prospects of even more cuts to interest rates and perhaps even depositor charges in future. </p>
<p>In the face of widespread popular disapproval, maintaining or even reducing these rates further would be very challenging for central banks. In the hunt for an answer to the global economic crisis, those in charge of monetary policy would be advised to look somewhere else.</p><img src="https://counter.theconversation.com/content/130718/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alla Koblyakova does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Will the all-time lowest rate in the world of -0.75% be enough for these alpine explorers?Alla Koblyakova, Senior Lecturer in Property Finance, Nottingham Trent UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1300982020-01-23T12:26:06Z2020-01-23T12:26:06ZQuantitative easing now looks permanent – and has turned central banks into pseudo governments<figure><img src="https://images.theconversation.com/files/311390/original/file-20200122-117907-9a9u0g.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Forever?</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/financial-technology-concept-fintech-foreign-exchange-1289383594">Metamorks</a></span></figcaption></figure><p>After a pause of a few months, the world’s leading central banks are “printing” money again to try to bolster their economies. Commonly known as quantitative easing or QE, the European Central Bank (ECB) <a href="https://www.forbes.com/sites/isabeltogoh/2019/09/12/what-to-expect-from-the-european-central-bank-decision/">resumed</a> its programme just before the turn of the year. The backdrop is <a href="https://www.aa.com.tr/en/economy/eu-sees-weak-growth-highest-employment-levels-in-q3/1664733">lukewarm growth</a>, a <a href="https://markets.businessinsider.com/news/stocks/german-gdp-economy-grew-01-in-3rd-quarter-avoids-recession-2019-11-1028688230">looming recession</a> in Germany, and <a href="https://www.telegraph.co.uk/business/2019/06/06/deflation-alert-europe-markets-lose-faith-powerless-ecb/">persistent fears</a> of Japanese-style deflation. </p>
<p>The ECB is creating new euros to buy bonds at a monthly pace of €20 billion (£17 billion). It is also signalling that QE has moved from being a temporary innovation to a permanent feature of monetary policy. </p>
<p>Meanwhile, the US Federal Reserve <a href="https://www.forbes.com/sites/greatspeculations/2019/12/11/is-the-fed-gearing-up-for-a-new-round-of-quantitative-easing/#60a3bc152c45">has also been</a> running a new asset-buying programme, creating US$60 billion (£46 billion) a month since September. It insists for technical reasons that this is not QE, though <a href="https://www.ft.com/content/27c0860e-394f-11ea-a6d3-9a26f8c3cba4">many observers</a> disagree. The Bank of Japan <a href="https://www.ft.com/content/164012f0-20c7-11ea-b8a1-584213ee7b2b">has been</a> following a similar policy almost continually <a href="https://www.reuters.com/article/us-japan-economy-boj/bank-of-japans-balance-sheet-now-larger-than-countrys-gdp-idUSKCN1NI07Z">for the past decade</a>, while there have been <a href="https://www.theguardian.com/business/2020/jan/09/bank-of-england-governor-mark-carney-hints-at-imminent-interest-rate-cut">recent hints</a> from the Bank of England that it might return to the fray for the <a href="https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2019/november-2019">first time</a> since 2016. </p>
<p>At the Davos World Economic Forum, the managing director of the IMF <a href="https://www.telegraph.co.uk/business/2020/01/21/alarmed-imf-really-thinks-davos/">has said that</a> these interventions, along with many other countries cutting interest rates, amount to the “most synchronised monetary easing since the global financial crisis”. </p>
<p>In the process, the balance sheets of the leading central banks have ballooned to many times their previous size. As we shall see, it has given them a direct role in industrial policy that few people are even aware of. </p>
<h2>Liquidity gets crunched</h2>
<p>It was the economic crisis of 2007-09 that drove the European, British and American central banks to try QE. They reduced interest rates to unprecedented levels, but it did little to increase bank lending, consumption or investment. By the turn of the decade, they realised their economies were caught in a similar liquidity trap to Japan, which <a href="https://www.investopedia.com/articles/markets/052516/japans-case-study-diminished-effects-qe.asp">had been pioneering</a> its own QE programme since the late 1990s. Nothing like this had been seen on a global scale <a href="https://www.telegraph.co.uk/finance/economics/2783215/Davos-2008-US-slides-into-dangerous-1930s-liquidity-trap.html">since the 1930s</a>. </p>
<p>So they began to create massive amounts of money to buy the bonds of governments, banks and other major companies. The idea was to drive up bond prices, which would at the same time drive down their yields or rate of interest. By doing this, long-term interest rates would be reduced in line with the cuts that the central banks had already made to short-term interest rates. This would make borrowing cheaper for those issuing the bonds, which would hopefully stimulate the economy. </p>
<p><strong>Central bank balance sheets 2006-18</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/311362/original/file-20200122-117933-1xtmcpv.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/311362/original/file-20200122-117933-1xtmcpv.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/311362/original/file-20200122-117933-1xtmcpv.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=342&fit=crop&dpr=1 600w, https://images.theconversation.com/files/311362/original/file-20200122-117933-1xtmcpv.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=342&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/311362/original/file-20200122-117933-1xtmcpv.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=342&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/311362/original/file-20200122-117933-1xtmcpv.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=430&fit=crop&dpr=1 754w, https://images.theconversation.com/files/311362/original/file-20200122-117933-1xtmcpv.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=430&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/311362/original/file-20200122-117933-1xtmcpv.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=430&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><span class="source">Central bank statistics</span></span>
</figcaption>
</figure>
<p>There has been much debate about whether QE has succeeded. It is <a href="https://theconversation.com/secular-stagnation-its-time-to-admit-that-larry-summers-was-right-about-this-global-economic-growth-trap-112977">often said that</a> along with low interest rates, it has paved the way for a new speculative bubble in riskier assets, while not unlocking enough growth to have achieved a recovery. We have never returned to the growth levels of the 2000s, as shown below.</p>
<p><strong>Global growth since 2000</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/311367/original/file-20200122-117933-6p7wxe.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/311367/original/file-20200122-117933-6p7wxe.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/311367/original/file-20200122-117933-6p7wxe.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=374&fit=crop&dpr=1 600w, https://images.theconversation.com/files/311367/original/file-20200122-117933-6p7wxe.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=374&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/311367/original/file-20200122-117933-6p7wxe.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=374&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/311367/original/file-20200122-117933-6p7wxe.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=470&fit=crop&dpr=1 754w, https://images.theconversation.com/files/311367/original/file-20200122-117933-6p7wxe.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=470&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/311367/original/file-20200122-117933-6p7wxe.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=470&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG">World Bank</a></span>
</figcaption>
</figure>
<p>Commentators like former US Treasury minister Lawrence Summers <a href="https://www.theguardian.com/business/2019/aug/26/central-bankers-conventional-tools-no-longer-working">argue that</a> instead of QE, governments should be spending our way to a stronger recovery by running higher deficits. But since there is little political will for this, others believe that QE is effectively the only game in town. </p>
<p>The ECB, which was <a href="https://www.ft.com/content/de4a958a-eab3-11e9-a240-3b065ef5fc55">fiercely criticised</a> from within the institution for resuming QE, <a href="https://www.ecb.europa.eu/pub/pdf/other/ecb.ebart201803_02.en.pdf">has pointed to</a> the benefits from the previous programme. In particular, it claims to have improved corporations’ credit access and levels of bank lending. We could add that the concerns about speculative bubbles overlook the fact that a shift in demand towards riskier assets <a href="https://www.bankofengland.co.uk/speech/2020/mark-carney-opening-remarks-at-the-future-of-inflation-targeting-conference">was precisely</a> the objective behind QE. </p>
<p>Some <a href="https://www.telegraph.co.uk/finance/economics/11165982/World-economy-so-damaged-it-may-need-permanent-QE.html">influential commentators</a> argue that QE should be used permanently, and the ECB seems to agree. The bank’s new president, Christine Lagarde, <a href="https://www.ecb.europa.eu/press/pressconf/2019/html/ecb.is190606%7E32b6221806.en.html">said in December</a>:</p>
<blockquote>
<p>We intend to continue reinvesting in full the principal payments from maturing securities purchased under [the QE programme] … for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.</p>
</blockquote>
<h2>The new industrialists</h2>
<p>It is usually overlooked that QE has also led the central banks into an industrial role that is normally restricted to governments (except the Fed, <a href="https://www.thebalance.com/tarp-bailout-program-3305895">which works</a> hand in hand with the US Treasury in this regard). For instance, while <a href="https://www.ecb.europa.eu/mopo/implement/omt/html/index.en.html">over 80%</a> of the ECB scheme buys government and other public sector bonds, a huge chunk still goes into corporate bonds and other assets. At the time of writing, the ECB holds €263 billion worth of corporate bonds – a very significant amount in relation to individual firms and the sectors in question. </p>
<p><a href="https://www.ecb.europa.eu/pub/economic-bulletin/html/eb201704.en.html#IDofBox2">According to</a> the ECB, 29% of these bonds were issued by French firms, 25% by German firms and 11% each by Spanish and Italian firms. As at September 2017, the sectors they came from included utilities (16%), infrastructure (12%), automotive (10%) and energy (7%). </p>
<p>Why were those firms and sectors targeted? The selection criteria are not always clear. Unsurprisingly, the investments have raised some political criticism. Some have argued, for example, that the money <a href="https://www.ft.com/content/d3f52ba6-fef2-11e9-b7bc-f3fa4e77dd47">should prioritise</a> green energy firms and <a href="https://www.positivemoney.eu/wp-content/uploads/2018/09/2018-Javier-Solana-%E2%80%93-Eurosystem-environmental-protection-2018.pdf">not the bonds</a> of companies that trade in fossil fuels. </p>
<p>At any rate, these central banks are now in the business of picking winners and losers in the corporate world. They’re likely to be embroiled in this for a long time: even if they did abandon QE, they are buying assets with lifespans of over 30 years in some cases. As the Bank of Italy <a href="https://www.bancaditalia.it/compiti/polmon-garanzie/pspp/index.html">has admitted</a>, the possibility of some of these companies going insolvent creates financial risks for the whole eurozone system. </p>
<p>It should be said that there are echoes of the past in these interventions. The likes of the Bank of England and Bank of Japan have been involved in salvaging firms or entire industrial sectors after economic downturns before. The Bank of England <a href="https://openaccess.city.ac.uk/id/eprint/7161/1/Bus_History_CRO_March_2015.pdf">came to own</a> a number of cotton mills in the 1920s, for instance, and then <a href="https://books.google.co.uk/books?id=P1auCwAAQBAJ&pg=PA98&lpg=PA98&dq=%22bank+of+england%22+%26+%22rolls-royce%22+rescue&source=bl&ots=tfLE8NuXdH&sig=ACfU3U2WWSxKC0U_6H5qiuKC6XmCjcbC7Q&hl=en&sa=X&ved=2ahUKEwjjx-GoupfnAhUDUcAKHcZqBeoQ6AEwB3oECAkQAQ#v=onepage&q=%22bank%20of%20england%22%20%26%20%22rolls-royce%22%20rescue&f=false">Rolls-Royce</a> in the famous 1970s rescue. Another example is France <a href="https://www.cambridge.org/core/books/controlling-credit/DBC22208B3268FBC00AB4135D7EDD37C">in the 1950s</a>, where the central bank became involved in choosing which sectors and companies to back under a scheme to distribute long-term finance. </p>
<p>The supposedly “unconventional” QE policies are therefore somewhat more conventional than is often admitted. We might like to think of central banks as technocratic institutions that merely enable the market, but not always. And the decisions about whom to prop up are being taken without any democratic input. For the situation to reverse and for the balance sheets of central banks to return to pre-crisis levels, it depends very much on whether we ever see a robust recovery. All we can say for now is that there are no signs of it yet.</p><img src="https://counter.theconversation.com/content/130098/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Valerio Cerretano does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>How many people realise that the central banks’ great programme for reviving the global economy involves hand-picking which companies and sectors to help out?Valerio Cerretano, Senior Lecturer in Management, University of GlasgowLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1276972019-11-26T23:33:23Z2019-11-26T23:33:23ZNow we know. The Reserve Bank has spelled out what it will do when rates approach zero<figure><img src="https://images.theconversation.com/files/303831/original/file-20191126-180279-1jwxnpk.jpg?ixlib=rb-1.1.0&rect=948%2C95%2C2929%2C1521&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">When the cash rate hits 0.25% the governor will pause for breath. After that he will buy state and federal government bonds, pushing longer term interest rates down towards zero.</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>Last night, in a much anticipated speech <a href="https://webcasting.boardroom.media/broadcast/5dd35bffab43773675923dad">broadcast live on the Reserve Bank’s website</a>, Governor Phil Lowe laid out in very clear terms the circumstances in which the bank would resort to quantitative easing and the way in which it would implement it.</p>
<p>Quantitative easing is simply a change in the way it eases monetary policy when the official interest rate approaches zero.</p>
<p>Usually it does it by cutting the so-called <a href="https://www.rba.gov.au/education/resources/explainers/how-rba-implements-monetary-policy.html">cash rate</a>, which is the rate banks pay each other for money deposited overnight. </p>
<p>Eight years ago the cash rate was 4.5%. Three years ago it was 1.5%. After the most recent three cuts in June, July and October, it is just 0.75%</p>
<hr>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/303837/original/file-20191126-112484-iegrak.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/303837/original/file-20191126-112484-iegrak.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/303837/original/file-20191126-112484-iegrak.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=158&fit=crop&dpr=1 600w, https://images.theconversation.com/files/303837/original/file-20191126-112484-iegrak.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=158&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/303837/original/file-20191126-112484-iegrak.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=158&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/303837/original/file-20191126-112484-iegrak.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=199&fit=crop&dpr=1 754w, https://images.theconversation.com/files/303837/original/file-20191126-112484-iegrak.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=199&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/303837/original/file-20191126-112484-iegrak.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=199&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="attribution"><a class="source" href="https://www.rba.gov.au/statistics/cash-rate/">Source: RBA</a></span>
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<p>Last night, Governor Lowe said the <a href="https://www.rba.gov.au/speeches/2019/sp-gov-2019-11-26.html">effective lower bound was 0.25%</a>. Rather than let the cash rate get any lower or negative (an option he explicitly ruled out), the bank will push down other longer-term rates by buying government bonds.</p>
<p>It’s the “quantitative easing” approach adopted by the US Federal Reserve between 2009 and 2014.</p>
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Read more:
<a href="https://theconversation.com/below-zero-is-reverse-how-the-reserve-bank-would-make-quantitative-easing-work-118843">Below zero is ‘reverse’. How the Reserve Bank would make quantitative easing work</a>
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<p>Government bonds are sold by governments in return for money, a means of borrowing. The buyer gets guaranteed interest payments and a guarantee that their money will be returned in full after three, five, ten or even 20 years depending on the length of the bond. </p>
<p>Once issued, bonds can be traded on a market, and the price at which they change hands can be expressed as an implied interest rate, which becomes the risk-free rate against which all other interest rates are benchmarked.</p>
<h2>How quantitative easing would work</h2>
<p>Buying bonds from investors would push down that risk-free rate, pushing down the entire structure of long-term interest rates.</p>
<p>All other things being equal, this should also push down the exchange rate by reducing the return on Australian dollar denominated financial investments.</p>
<p>Governor Lowe indicated he might buy state government bonds as well as Commonwealth bonds. </p>
<p>Importantly, he argued that although the bank would be mindful of the need to ensure private banks had enough access to the bonds they needed to hold for regulatory purposes, those holdings would not be an impediment to quantitative easing.</p>
<p>He ruled out buying residential mortgage-backed securities and other private assets given that those markets are currently functioning well and Reserve Bank purchases could distort them.</p>
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Read more:
<a href="https://theconversation.com/rba-update-governor-lowe-points-to-even-lower-rates-121690">RBA update: Governor Lowe points to even lower rates</a>
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<p>The approach borrows heavily from the US Fed. </p>
<p>As in the US, Lowe says quantitative easing would be complemented by “forward guidance,” where the Reserve Bank would signal early how long-term interest rates would be kept low and the circumstances in which it expected to raise them again.</p>
<p>The guidance is designed to influence market expectations for future interest rates, enhancing the effectiveness of cuts in long term interest rates.</p>
<h2>When it would happen</h2>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/303863/original/file-20191126-112493-z5h6as.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/303863/original/file-20191126-112493-z5h6as.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/303863/original/file-20191126-112493-z5h6as.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=971&fit=crop&dpr=1 600w, https://images.theconversation.com/files/303863/original/file-20191126-112493-z5h6as.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=971&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/303863/original/file-20191126-112493-z5h6as.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=971&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/303863/original/file-20191126-112493-z5h6as.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1220&fit=crop&dpr=1 754w, https://images.theconversation.com/files/303863/original/file-20191126-112493-z5h6as.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1220&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/303863/original/file-20191126-112493-z5h6as.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1220&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">RBA governor Philip Lowe addressed business economists in Sydney on Tuesday night.</span>
<span class="attribution"><span class="source">DEAN LEWINS/AAP</span></span>
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<p>In addition to “how,” Governor Lowe spelled out “when” – the economic circumstances in which the bank would resort to quantitative easing. </p>
<p>It would do it when the cash rate was at 0.25% and inflation and unemployment were moving away from its objectives.</p>
<p>The bank targets 2-3% inflation on average over time and has recently identified 4.5% as the “full employment” unemployment rate.</p>
<p>Importantly, Lowe emphasised that the Australian economy has not yet reached the point where a cash rate as low as 0.25% would be needed and argued quantitative easing was unlikely to be needed in future.</p>
<p>The cash rate is at present 0.75%. Setting 0.25% as the effective lower bound gives the Governor 0.5 percentage points left to cut before implementing quantitative easing.</p>
<p>Implicitly, Governor Lowe is saying that those cuts of 0.5 percentage points will be enough to stabilise the economy.</p>
<h2>A pause for a breath at 0.25%</h2>
<p>Lowe also indicated the bank would not seamlessly transition to quantitative easing. </p>
<p>He implied there was an additional hurdle or threshold that would need to be crossed, suggesting he would be reluctant to make the transition.</p>
<p>His big problem is that neither inflation nor the unemployment rate are moving in the right direction.</p>
<p>The bank has undershot its inflation target since the end of 2014, giving the economy a weak starting point going into an emerging global downturn.</p>
<p>My <a href="https://www.ussc.edu.au/analysis/lessons-from-quantitative-easing-in-the-united-states-a-guide-for-australian-policymakers">research</a> on the US experience for the United States Studies Centre shows that the main problem with is quantitative easing was that it was not done soon enough or aggressively enough.</p>
<h2>It might be better to be bold</h2>
<p>While quantitative easing was effective, it could have been made more so had what was going to happen been made clearer.</p>
<p>The Fed went out of its way to limit the transmission of quantitative easing to the rest of the economy, fearful it would be too potent and lead to excessive inflation.</p>
<p>Those concerns proved misplaced. By pulling its punches, the Fed ended up being less effective and having to pursue quantitative easing for longer than if it had used it more aggressively.</p>
<p>Governor Lowe’s very obvious reluctance to go down the quantitative easing route suggests the Reserve Bank is in danger of making the same mistake, but it is not too late to learn from what happened in the US.</p><img src="https://counter.theconversation.com/content/127697/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Stephen Kirchner is affiliated with the United States Studies Centre and the Fraser Institute.</span></em></p>In a speech broadcast live on the Reserve Bank website, the governor explained how quantitative easing would work. He won’t try it until the cash rate hits 0.25%.Stephen Kirchner, Program Director, Trade and Investment, United States Studies Centre, University of SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1267652019-11-25T19:09:09Z2019-11-25T19:09:09ZThe RBA has a new brain. It has thoughts on what’ll happen after interest rates hit zero<figure><img src="https://images.theconversation.com/files/303370/original/file-20191125-74576-7fhv5n.jpg?ixlib=rb-1.1.0&rect=472%2C232%2C1814%2C925&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">MARTIN is helping the Reserve Bank see beyond its headquarters in Martin Place. And it's open source, giving outsiders an insight into its thinking.</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>MARTIN stands for “<a href="https://www.rba.gov.au/publications/rdp/2019/pdf/rdp2019-07.pdf">Macroeconomic Relationships for Targeting Inflation</a>”, or perhaps merely for “Martin Place” which is the location of the Reserve Bank’s headquarters in Sydney.</p>
<p>It’s the bank’s new computer model of the Australian economy, made up of 147 equations working in concert. Some are quite simple, such as how global oil prices affect domestic petrol prices, whereas others are more complex, such as how a rise in the unemployment rate affects household spending.</p>
<p>Unveiled in August in a discussion paper entitled “<a href="https://www.rba.gov.au/publications/rdp/2019/pdf/rdp2019-07.pdf">MARTIN has its place</a>”, the model is available for use by analysts outside the bank for whom it can serve as something of a guide as to what the bank might be thinking.</p>
<p>It provides useful insights into what the bank will do next, after it has cut its cash rate as close to zero as possible and needs to stimulate the economy further.</p>
<p>It’s a topic Governor Philip Lowe will expand on tonight in a landmark speech to <a href="https://webcasting.boardroom.media/broadcast/5dd35bffab43773675923dad">business economists in Sydney</a>.</p>
<h2>What’s MARTIN, what’s a model?</h2>
<p>Economists use models like drivers use maps – to take a large and complicated country and simplify it to its essential ingredients in the hopes of providing a useful guide to navigating it. </p>
<p>A map doesn’t tell you everything about a route – that would be hard to come to grips with – but it highlights important features or paths you should watch for. Models do the same – simplifying the complex Australian economy into the paths that matter.</p>
<p>But instead of breaking Australia down into rivers and roads, or cities and states like a map might do, MARTIN divides the Australian economy into different sectors such as households, firms and the government with the 147 equations describing the ways they interlink with each other.</p>
<p>This map is principally designed for two purposes. </p>
<ul>
<li><p>The first is forecasting. Every three months the bank looks inside its crystal ball to try and divine how the economy will evolve in the years to come. MARTIN has become a key input into that process.</p></li>
<li><p>The second use is the ability to run “what if” simulations to see how the economy would react in different scenarios. For example, what would happen if the price of iron ore crashed tomorrow, or what would be the impact if the government ramped up its spending on infrastructure?</p></li>
</ul>
<h2>What does MARTIN say about quantitative easing?</h2>
<p>MARTIN will have been put to work pondering the implications of deploying so-called “quantitative easing” after the Reserve Bank’s cash rate gets too low to cut.</p>
<p>Quantitative easing involves the Reserve Bank buying financial assets, such as government or mortgage bonds, in order to continue to supply money to the economy after its cash rate has fallen to zero.</p>
<p>I have used MARTIN to model three different scenarios for quantitative easing in the Australian economy. </p>
<p>The first is what would happen if quantitative easing isn’t used at all. </p>
<p>The second is what would happen if the bank started a modest quantitative easing program in early 2020 lasting around a year.</p>
<p>The third is what would happen if the bank commenced an aggressive quantitative easing program to simulate the economy for 18 months. </p>
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<em>
<strong>
Read more:
<a href="https://theconversation.com/below-zero-is-reverse-how-the-reserve-bank-would-make-quantitative-easing-work-118843">Below zero is ‘reverse’. How the Reserve Bank would make quantitative easing work</a>
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<p>I assume the bank would purchase assets in a similar manner to how the US conducted quantitative easing after the global financial crisis, buying bonds to lower interest rates on two year and ten year government securities.</p>
<p>MARTIN says quantitative easing would have two major effects on the economy. First, it would lower the cost of borrowing for Australian businesses. They would be expected to increase investment as more projects become viable as the interest rates they were charged fell.</p>
<p>Second, the lower rate structure would weaken the Australian dollar by as much as 5 US cents. A cheaper dollar would make our exports more competitive and make foreign imports more expensive. </p>
<h2>MARTIN thinks it could work</h2>
<p>MARTIN predicts quantitative easing would boost manufacturing, agriculture and mining exports relative to where they would be without it. </p>
<p>The depreciation would also encourage Australian households to spend more on local goods and less on what would be dearer imports. This should lead to higher wages, increased household incomes and spending, and improved economic growth. </p>
<p>In fact, MARTIN predicts that, by boosting economic growth, quantitative easing would actually lead to higher interest rates as inflation returns to the Reserve Bank’s target, allowing interest rates to return to more normal levels.</p>
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<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/we-asked-13-economists-how-to-fix-things-all-back-the-rba-governor-over-the-treasurer-126283">We asked 13 economists how to fix things. All back the RBA governor over the treasurer</a>
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<p>Combining these two effects, MARTIN suggests a large quantitative easing program would reduce unemployment by 0.3 percentage points, equivalent to 40,000 extra jobs, and boost wages across the economy.</p>
<p>The output of any model is only as good as the information and data that are fed into it, but the output of MARTIN is why more and more economists expect the bank to quantitatively ease in the new year. Its brain says it should work.</p><img src="https://counter.theconversation.com/content/126765/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Isaac Gross is a former employee of the RBA & member of the ALP.</span></em></p>MARTIN stands for “Macroeconomic Relationships for Targeting Inflation”. The bank’s new computer model says there’s much it can do to boost the economy after its cash rate hits zero.Isaac Gross, Lecturer in Economics, Monash UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1188432019-06-17T19:56:50Z2019-06-17T19:56:50ZBelow zero is ‘reverse’. How the Reserve Bank would make quantitative easing work<figure><img src="https://images.theconversation.com/files/279731/original/file-20190617-158925-nnpy1t.jpg?ixlib=rb-1.1.0&rect=1609%2C616%2C3642%2C2057&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Road tested. Quantitative easing worked in the US, and can work even better here.</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>With its official cash rate now expected to fall below 1% to a new extraordinarily low close to zero, all sorts of people are saying that the Reserve Bank is in danger of “<a href="https://www.reuters.com/article/us-australia-economy-rba-analysis/australias-shrinking-monetary-policy-arsenal-tests-rbas-orthodoxy-idUSKCN1S90CL">running out of ammunition.</a>” Ammunition might be needed if, as during the last financial crisis, it needs to cut rates by several percentage points.</p>
<p>This view assumes that when the cash rate hits zero there is nothing more the Reserve Bank can do. </p>
<p>The view is not only wrong, it is also dangerous, because if taken seriously it would mean that all of the next rounds of stimulus would have to come from fiscal (spending and tax) policy, even though fiscal policy is probably ineffective long-term, its effects being <a href="https://www.mercatus.org/publication/why-fiscal-multiplier-roughly-zero-0">neutralised by a floating exchange rate</a>.</p>
<p>The experience of the United States shows that Australia’s Reserve Bank could quite easily take measures that would have the same effect as cutting its cash rate a further 2.5 percentage points – that is: 2.5 percentage points below zero. </p>
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<p><strong>Reserve Bank cash rate since 1990</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/277841/original/file-20190604-69059-1j2m4r9.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/277841/original/file-20190604-69059-1j2m4r9.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/277841/original/file-20190604-69059-1j2m4r9.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=126&fit=crop&dpr=1 600w, https://images.theconversation.com/files/277841/original/file-20190604-69059-1j2m4r9.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=126&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/277841/original/file-20190604-69059-1j2m4r9.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=126&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/277841/original/file-20190604-69059-1j2m4r9.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=158&fit=crop&dpr=1 754w, https://images.theconversation.com/files/277841/original/file-20190604-69059-1j2m4r9.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=158&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/277841/original/file-20190604-69059-1j2m4r9.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=158&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="attribution"><a class="source" href="https://www.rba.gov.au/media-releases/2019/mr-19-15.html">Reserve Bank of Australia</a></span>
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<p>In a report <a href="https://www.ussc.edu.au/analysis/lessons-from-quantitative-easing-in-the-united-states-a-guide-for-australian-policymakers">released on Tuesday</a> by the University of Sydney’s United States Studies Centre, I document the successes and failures of the US approach to so-called “quantitative easing” (QE) between 2009 and 2014.</p>
<p>It demonstrates that it is always possible to change the instrument of monetary policy from changes in the official interest rate to changes in other interest rates by buying and holding other financial instruments such as long-term government and corporate bonds.</p>
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<img alt="" src="https://images.theconversation.com/files/279752/original/file-20190617-118539-fe387p.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/279752/original/file-20190617-118539-fe387p.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=837&fit=crop&dpr=1 600w, https://images.theconversation.com/files/279752/original/file-20190617-118539-fe387p.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=837&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/279752/original/file-20190617-118539-fe387p.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=837&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/279752/original/file-20190617-118539-fe387p.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1052&fit=crop&dpr=1 754w, https://images.theconversation.com/files/279752/original/file-20190617-118539-fe387p.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1052&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/279752/original/file-20190617-118539-fe387p.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1052&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Australia can learn form US mistakes.</span>
<span class="attribution"><a class="source" href="https://www.ussc.edu.au/analysis/lessons-from-quantitative-easing-in-the-united-states-a-guide-for-australian-policymakers">University of Sydney United States Studies Centre</a></span>
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<p>The more aggressively the Reserve Bank buys those bonds from private sector owners, the lower the long-term interest rates that are needed to place bonds and the more former owners whose hands are filled with cash that they have to make use of.</p>
<p>In the US the Federal Reserve also used “<a href="https://www.federalreserve.gov/monetarypolicy/timeline-forward-guidance-about-the-federal-funds-rate.htm">forward guidance</a>” about the likely future path of the US Federal funds rate to convince markets the rate would be kept low for an extended period.</p>
<p>It is unclear which mechanism was the most powerful, or whether the Fed even needed to buy bonds in order to make forward guidance work. However in a stressed economic environment, it is worth trying both.</p>
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Read more:
<a href="https://theconversation.com/the-reserve-bank-will-cut-rates-again-and-again-until-we-lift-spending-and-push-up-prices-118263">The Reserve Bank will cut rates again and again, until we lift spending and push up prices</a>
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<p>As it comes to be believed that interest rates will stay low for an extended period, the exchange rate will fall, making it easier for Australian corporates to borrow from overseas and to export and compete with imports.</p>
<p>The consensus of the academic literature is that QE cut long-term interest rates by around one percentage point and had economic effects equivalent to cutting the US Federal fund rate by <a href="https://www.ussc.edu.au/analysis/lessons-from-quantitative-easing-in-the-united-states-a-guide-for-australian-policymakers">a further 2.5 percentage points</a> after it approached zero.</p>
<h2>QE need not have limits…</h2>
<p>Based on US estimates, Australia’s Reserve Bank would need to purchase assets equal to around 1.5% of Australia’s Gross Domestic Product to achieve the equivalent of a 0.25 percentage point reduction in the official cash rate. That’s around A$30 billion.</p>
<p>With over A$780 billion in long-term government (Commonwealth and state) securities on issue, there’s enough to accommodate a very large program of Reserve Bank buying, and the bank could also follow the example of the Fed and expand the scope of purchases to include non-government securities, including residential mortgage-backed securities.</p>
<p>It could also learn from US mistakes. The Fed was slow to cut its official interest rate to near zero and slow to embark on QE in the wake of the 2008 financial crisis. Its first attempt was limited in size and duration. Its success in using QE to stimulate the economy should be viewed as the lower bound of what’s possible.</p>
<h2>…even if it becomes less effective as it grows</h2>
<p>It’s often <a href="https://www.abc.net.au/news/2019-06-16/interest-rates-are-going-down-but-how-low-can-they-go/11210682">suggested</a> (although it is <a href="https://www.rba.gov.au/publications/confs/2017/borio-hofmann.html">by no means certain</a>) that monetary policy becomes less effective when interest rates get very low, but this isn’t necessarily an argument to use monetary policy less. It could just as easily be an argument to use it more.</p>
<p>Because there is no in-principle limit to how much QE a central bank can do, it is always possible to do more and succeed in lifting the inflation rate and spending.</p>
<p>Fiscal policy may well be even less effective. To the extent that it succeeds, it is likely to push up the Australian dollar, making Australian businesses less competitive. </p>
<p>US economist <a href="https://www.mercatus.org/publication/why-fiscal-multiplier-roughly-zero-0">Scott Sumner</a> believes the extra bang for the buck from government spending or tax cuts (known as the multiplier) is close to zero.</p>
<p>Reserve Bank Governor Philip Lowe this month appealed for <a href="https://www.rba.gov.au/speeches/2019/sp-gov-2019-06-04.html">help from the government itself</a>, asking in particular for extra spending on infrastructure and measures to raise productivity growth. </p>
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Read more:
<a href="https://theconversation.com/vital-signs-if-we-fall-into-a-recession-and-we-might-well-have-ourselves-to-blame-118387">Vital Signs. If we fall into a recession (and we might) we'll have ourselves to blame</a>
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<p>He is correct in identifying the contribution other policies can make to driving economic growth. No one seriously thinks Reserve Bank monetary policy can or should substitute for productivity growth. </p>
<p>But it is a good, perhaps a very good, substitute for government spending that does not contribute to productivity growth.</p>
<h2>Three myths about quantitative easing</h2>
<p>In the paper I address several myths about QE. One is that it is “printing money”. It no more prints money than does conventional monetary policy. It pushes money into private sector hands by adjusting interest rates, albeit a different set of rates.</p>
<p>Another myth is that it promotes inequality by helping the rich to get richer.</p>
<p>It is a widely believed myth. Former Coalition treasurer <a href="https://www.afr.com/news/economy/monetary-policy/murdoch-criticises-central-bank-stimulus-20141017-119n1f">Joe Hockey</a> told the British Institute of Economic Affairs in 2014 that:</p>
<blockquote>
<p>Loose monetary policy actually helps the rich to get richer. Why? Because we’ve seen rising asset values. Wealthier people hold the assets.</p>
</blockquote>
<p>But it widens inequality no more than conventional monetary policy, and may not widen it at all if it is successful in maintaining sustainable economic growth.</p>
<p>A third myth is that it leads to excessive inflation or socialism.</p>
<p>In the US it has in fact been associated with some of the lowest inflation since the second world war. These days central banks are more likely to err on the side of creating too little inflation than too much.</p>
<p>Some have argued that QE in the US is to blame for the rise of left-wing populists
like Alexandria Ocasio-Cortez and “<a href="https://realconservativesunite.com/2019/03/07/ben-bernanke-the-father-of-extreme-us-socialism/">millennial socialism</a>”. But it is probably truer to say that their grievances grew out of too tight rather than too loose monetary policy.</p>
<p>QE has been road tested. We’ve little to fear from it, just as we have had little to fear from conventional monetary policy.</p><img src="https://counter.theconversation.com/content/118843/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Stephen Kirchner is affiliated with the Fraser Institute.</span></em></p>There’s nothing unusual about quantitative easing. Our biggest mistake would be to be to wait.Stephen Kirchner, Program Director, Trade and Investment, United States Studies Centre, University of SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1183872019-06-06T19:31:29Z2019-06-06T19:31:29ZVital Signs. If we fall into a recession (and we might) we’ll have ourselves to blame<figure><img src="https://images.theconversation.com/files/278340/original/file-20190606-98033-14nb9ij.jpg?ixlib=rb-1.1.0&rect=103%2C342%2C2621%2C1090&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The Reserve Bank and government have the means to keep us from recession. They'll need the will. </span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>The facts are not in dispute. </p>
<p>Annual GDP growth has fallen to <a href="https://www.abs.gov.au/ausstats/abs@.nsf/mf/5206.0">1.8%</a>. On a per-capita basis we have had three consecutive quarters of negative growth. The last time that happened was during the drought and recession of <a href="https://theconversation.com/expect-weak-economic-growth-for-quite-some-time-what-wednesdays-national-accounts-tell-us-118273">1982</a>, almost four decades years ago.</p>
<p>The most recent inflation reading was literally <a href="https://theconversation.com/vital-signs-zero-inflation-means-the-reserve-bank-should-cut-rates-as-soon-as-it-can-on-tuesday-week-115931">zero</a>. Real wage growth has been stagnant <a href="https://theconversation.com/this-is-what-policymakers-can-and-cant-do-about-low-wage-growth-101025">for six years</a>. Household debt is nearly <a href="https://bit.ly/2K0KbIZ">double</a> disposable income. And underemployment is <a href="https://www.abs.gov.au/ausstats/abs@.nsf/mf/6202.0">more than 8%</a>, on top of a 5.2% rate of unemployment.</p>
<p>What is in dispute is what to do about it.</p>
<h2>We’ve entered secular stagnation</h2>
<p>After being been told for years that the economy is in good shape and that we are <a href="https://www.businessinsider.com.au/video-prime-minister-malcolm-turnbull-on-his-1-billion-ideas-boom-2015-12">“transitioning away from the mining boom”</a>, it’s time to face the reality that, like most advanced economies, we are in a low-growth, low-interest rate, low-inflation trap.</p>
<p>Former US Treasury Secretary Larry Summers has argued for some time that advanced economies, almost universally, are suffering from what he calls “<a href="https://theconversation.com/secular-stagnation-its-time-to-admit-that-larry-summers-was-right-about-this-global-economic-growth-trap-112977">secular stagnation</a>” — a protracted period of low growth caused by too much savings chasing too few productive investment opportunities. </p>
<p>If the description applies to us, and it does, there are only two ways to escape it.</p>
<h2>We’ve two options</h2>
<p>One is unconventional monetary policy: measures that have the effect that pushing interest rates below zero would have.</p>
<p>The other is aggressive fiscal policy: either big (and if necessary, repeated) tax cuts or a big (and if necessary, repeated) boost in government spending, each of which would put the <a href="https://theconversation.com/vital-signs-when-it-came-to-the-surplus-both-bill-and-scott-were-having-a-lend-116806">surplus</a> at risk.</p>
<p>What would an aggressive-enough monetary policy look like?</p>
<p>The starting point is a concept known as the “equilibrium real interest rate”. It’s the real (inflation-adjusted) rate of interest consistent with stable macroeconomic performance (which means full employment without financial bubbles).</p>
<h2>1: Aggressive monetary policy</h2>
<p>There is <a href="https://www.brookings.edu/wp-content/uploads/2019/03/On-Falling-Neutral-Real-Rates-Fiscal-Policy-and-the-Risk-of-Secular-Stagnation.pdf">compelling evidence</a> that in advanced economies such as Australia the equilibrium real interest rate is negative.</p>
<p>But getting there in a low-inflation environment is hard. The Reserve Bank can, if it chooses, set the cash rate as low as 0% (<a href="https://theconversation.com/the-reserve-bank-will-cut-rates-again-and-again-until-we-lift-spending-and-push-up-prices-118263">this week it cut it to 1.25%</a>) but it can’t safely move it much lower than zero. If it did, if people and firms found themselves having to pay money in order to keep money in banks, they might simply take their money out, giving the Reserve Bank even less control.</p>
<p>This problem is known as the “zero lower bound”. It means that if the bank needs to cut rates beyond than zero it’ll probably have to do something else that has a similar effect. </p>
<p>The most likely candidate is “<a href="https://theconversation.com/now-is-the-time-to-plan-how-to-fight-the-next-recession-111497">quantitative easing</a>” (QE), whereby the central bank buys long-term government bonds and other securities from investors that have them, effectively forcing cash into their hands, which the zero interest rate means they have little choice but to spend.</p>
<p>It shows up in lower longer-term interest rates (rates for borrowing 5, 10 or even 30 years into the future) and should boost spending and borrowing just as much as cutting short-term rates. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/secular-stagnation-its-time-to-admit-that-larry-summers-was-right-about-this-global-economic-growth-trap-112977">Secular stagnation: it's time to admit that Larry Summers was right about this global economic growth trap</a>
</strong>
</em>
</p>
<hr>
<p>There are at least three difficulties with QE in Australia. </p>
<p>The first is that because the Reserve Bank has never done it before, there are questions about how it would mechanically execute on it. The United States and European experience is helpful in providing a template.</p>
<p>The second difficulty is getting out. Nobody, including the US Federal Reserve, really knows what happens when QE is unwound.</p>
<p>Third, if secular stagnation persists, then QE needs to be a long-term strategy. But is it possible for a central bank to expand its balance sheet buying bonds and securities indefinitely, even if it was buying them at a modest pace? Again, nobody knows.</p>
<h2>2: Aggressive fiscal policy</h2>
<p>If nothing else, the headaches with monetary policy suggest that fiscal policy might be an attractive alternative. It might also be more effective.</p>
<p>As Reserve Bank governor Philip Lowe noted <a href="https://www.rba.gov.au/speeches/2019/sp-gov-2019-06-04.html">in a speech on Tuesday</a>, done in a good way government spending on infrastructure could both boost the economy and boost longer term productivity, giving a double benefit. It could be complemented by “structural policies that support firms expanding, investing, innovating and employing people”.</p>
<p>It’s hard to argue with Lowe’s logic. So hard in fact that some of us have been saying <a href="https://www.afr.com/opinion/big-project-spending-a-good-way-to-kickstart-stagnant-economy-20150819-gj2i7v">exactly what he just said for some time</a>.</p>
<p>A quicker way to boost the economy would be to splash cash, either as Kevin Rudd did in the form of cash payments during the global financial crisis, or in the form of <a href="https://theconversation.com/its-the-budget-cash-splash-that-reaches-back-in-time-114188">tax offsets</a> of the kind the Morrison government announced in the 2018 and 2019 budgets.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/its-the-budget-cash-splash-that-reaches-back-in-time-114188">It’s the budget cash splash that reaches back in time</a>
</strong>
</em>
</p>
<hr>
<p>Delivered straight into bank accounts, both have <a href="https://theconversation.com/election-tip-23-9-is-a-meaningless-figure-ignore-the-tax-to-gdp-ratio-115432">much the same effect</a>, even though one is classified as spending and the other as cutting tax.</p>
<p>The obstacle to doing such things is this government’s – make that this country’s – obsession with balanced budgets.</p>
<h2>The surplus can wait</h2>
<p>I have <a href="https://theconversation.com/vital-signs-do-deficits-matter-any-more-112680">argued strongly</a> and still believe that debt and deficits do matter, but at the moment we are in serious danger of falling into recession. That makes it imperative to act.</p>
<p>Given the politics of budget deficits and the narratives around economic management, it might be that the burden of action falls on the organisation the least able to pull it off in the present circumstances. That’s the Reserve Bank.</p>
<p>If Australia does dip into recession in the next year or two it will be an unforced error. </p>
<p>Not only would the government be responsible for it by not having taken strong enough action on spending when it could, the bank would also be responsible by taking action too late and letting things get to the stage where it had to act while interest rates were near zero.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/expect-weak-economic-growth-for-quite-some-time-what-wednesdays-national-accounts-tell-us-118273">Expect weak economic growth for quite some time. What Wednesday's national accounts tell us</a>
</strong>
</em>
</p>
<hr>
<img src="https://counter.theconversation.com/content/118387/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Richard Holden does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>We’ve two options of keeping ourselves out of recession, neither of them easy. The government will have to abandon its determination to get the budget into surplus.Richard Holden, Professor of Economics, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/703552016-12-14T12:24:34Z2016-12-14T12:24:34ZEurozone QE creates breathing space – here’s what governments must do now<p>The European Central Bank’s <a href="http://www.wsj.com/articles/ecb-to-extends-stimulus-program-by-nine-months-at-reduced-rate-1481201978">announcement</a> of a potentially indefinite, albeit tapered, extension of its quantitative easing (QE) programme appears very different to what is happening elsewhere. The US <a href="https://www.thebalance.com/what-is-quantitative-easing-definition-and-explanation-3305881">halted</a> its programme last year, while the UK’s <a href="http://www.economist.com/news/britain/21704762-how-misunderstanding-about-qe-led-lots-misleading-headlines-bank-englands-new">return</a> to QE in response to Brexit seems, for the moment, to be temporary. The US also <a href="http://www.forbes.com/sites/sarahsu/2016/12/12/bad-news-for-china-fed-reserve-expected-to-raise-interest-rates-this-week/#62815cf9377c">raised interest rates</a> on December 14 and signalled more rises next year, a move in the opposite direction. What are we to make of it all?</p>
<p>The ECB was late to quantitative easing, the stimulus system that sees central banks create new money to buy assets from other banks. It launched its programme to spend €60 billion on bonds each month as recently as March 2015. Having increased to €80 billion/month in April of this year, the new announcement extends the current end of the programme by nine months to the end of 2017 and cuts monthly buying back to €60 billion. By the current end date, the total stimulus will have been €2.2 trillion (£1.8 trillion).</p>
<p>By comparison, quantitative easing in the US ran from 2008-15 and totalled US$3.7 trillion (£2.9 trillion), while <a href="http://www.bbc.co.uk/news/business-15198789">the UK’s</a> £375 billion programme ran from 2009-12 before its August revival for a further £70 billion of purchases. On the other hand, Japan is still aggressively using QE, and will hit about £1.9 trillion by year end and £2.4 trillion by the end of 2017. </p>
<p><strong>Quantitative easing around the world</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/149930/original/image-20161213-1620-10n0pd2.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/149930/original/image-20161213-1620-10n0pd2.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/149930/original/image-20161213-1620-10n0pd2.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=312&fit=crop&dpr=1 600w, https://images.theconversation.com/files/149930/original/image-20161213-1620-10n0pd2.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=312&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/149930/original/image-20161213-1620-10n0pd2.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=312&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/149930/original/image-20161213-1620-10n0pd2.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=392&fit=crop&dpr=1 754w, https://images.theconversation.com/files/149930/original/image-20161213-1620-10n0pd2.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=392&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/149930/original/image-20161213-1620-10n0pd2.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=392&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">*Figures reflect stimulus by end 2016.</span>
</figcaption>
</figure>
<p>QE is the ECB’s response to <a href="http://ec.europa.eu/eurostat/web/hicp/publications/news-releases">deflation</a> in the eurozone in the aftermath of the 2007-08 financial crisis. These years of debt reduction by households, firms and countries have the potential to lead to a widespread contraction. QE helps prevent this by pumping money into the system, thereby putting a floor on the money/liquidity supply and hence asset prices and aggregate demand. </p>
<p>Under the programme, the ECB buys sovereign and corporate bonds from banks within the eurozone. This drives up the prices of the bonds, which simultaneously reduces their yields (interest rates) and improves the balance sheets of the banks that hold such assets. This should enable them to lend at the most competitive rates possible. </p>
<p>QE also causes currencies to depreciate, meaning it should stimulate exports – and sure enough the euro <a href="https://www.ebury.com/blog/ebury_post/euro-falls-sharply-ecb-qe-surprise/">promptly fell</a> against the dollar and pound after the latest ECB announcement. This more favourable climate then props up share markets and the prices of other assets such as commodities and bonds as investors snap up what they see as bargains. </p>
<p>Apart from the fact that the monthly stimulus has been cut by a quarter, the other <a href="http://blogs.wsj.com/dailyshot/2016/12/08/wsjs-daily-shot-the-market-is-ignoring-the-reality-of-trumps-fed/">notable change</a> to the ECB’s programme is that it is now prepared to buy bonds with a maturity of less than two years and with a yield of less than -0.4%. This is basically a signal that there are not enough longer term, higher yield bonds available, which has important consequences. </p>
<p>As was demonstrated after the announcement, the yields on the short-term sovereign bonds of especially Germany <a href="http://www.reuters.com/article/eurozone-bonds-idUSL5N1E41L9">fell sharply</a>, but the yields on longer term debt rose – meaning market demand for the short-term bonds was up while for the long-term bonds it was down. The effect was particularly pronounced for the sovereign bonds of Italy, Spain and Portugal. It is long-term bonds that affect interest rates for businesses and consumers. By stimulating demand for short-term bonds, the ECB is instead offering an opportunity for governments like Germany to access cheaper money by issuing more of them. </p>
<h2>The limits of QE</h2>
<p>The benefits to the private sector from eurozone QE in the future look limited – it is unlikely to make money much cheaper for them and in any case the <a href="http://dx.doi.org/10.1093/oxrep/grs029">evidence is mixed</a> that QE stimulates aggregate demand over the medium term. Business investment and consumer spending are therefore only likely to pick up in a sustainable way when people and companies become more positive about the prospects for the economy. </p>
<p>In the meantime, public sector investment on the back of the cheaper short-term bonds has a key role to play in stimulating growth. The cost of public sector borrowing in the eurozone is at <a href="https://www.ft.com/content/a70a6454-7639-11e4-a777-00144feabdc0">historical lows</a>, making it affordable for governments to cut their deficits at a slower pace. </p>
<p>This has made a stronger economic case for greater government investment in public goods like infrastructure, research funding, higher education, training and skills, and green technology. One attraction of such policies is that they encourage business investment in the longer term by tempting companies with everything from better educated workforces to infrastructure contracts to lucrative subsidies. </p>
<p>One stumbling block is that less competitive countries such as Greece have been expected to adjust their economies with <a href="https://www.theguardian.com/world/2016/may/08/rioters-take-to-the-streets-ahead-of-greek-austerity-vote">severe cuts</a> to public spending (since the old solution of devaluing the drachma is not an option in a currency zone). If we are relying on governments to take advantage of the conditions created by QE, we have to stop hampering them in this way. The eurozone potentially needs to look instead at the case for creditor countries like Germany spending more – potentially changing <a href="http://voxeu.org/article/secular-stagnation-eurozone">the rules</a> by which the eurozone is run. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/149933/original/image-20161213-1594-564trn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/149933/original/image-20161213-1594-564trn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/149933/original/image-20161213-1594-564trn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=401&fit=crop&dpr=1 600w, https://images.theconversation.com/files/149933/original/image-20161213-1594-564trn.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=401&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/149933/original/image-20161213-1594-564trn.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=401&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/149933/original/image-20161213-1594-564trn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=504&fit=crop&dpr=1 754w, https://images.theconversation.com/files/149933/original/image-20161213-1594-564trn.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=504&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/149933/original/image-20161213-1594-564trn.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=504&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Greek tragedy.</span>
<span class="attribution"><a class="source" href="http://www.shutterstock.com/pic-399617317/stock-photo-national-flag-of-greece-with-a-large-display-of-daily-stock-market-price-and-quotations-during-depressed-economic-period-the-fate-and-mystery-of-athens-stock-market-tunnel-corridor-con.html?src=skFGJd2vRUwBigCCDCvKrQ-1-68">William Potter</a></span>
</figcaption>
</figure>
<p>The instability caused by very different economies using the same currency remains the key policy concern in the eurozone, but other issues will not go away. These include underlying anxieties about inequality, the impact of an ageing population on the sustainability of the welfare state and the relative power and privilege of Western economies. This points to the need for reforms to things like state pension systems and healthcare and restructuring struggling economies. </p>
<p>What eurozone QE is doing is to give governments the breathing space to make changes that will unlock private investment and make national finances more viable before national debts become unmanageable. But QE cannot go further and be a substitute for these kinds of reforms. Policy reform that encourages innovation, education and trade will eventually lead to more growth in the eurozone. The challenge is to hold the bloc together and avoid a financial crisis long enough to let them take effect.</p><img src="https://counter.theconversation.com/content/70355/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Sayantan Ghosal does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Quantitative easing cannot single-handedly save Europe.Sayantan Ghosal, Professor of Economics, University of GlasgowLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/473812015-09-14T05:27:20Z2015-09-14T05:27:20ZHow to save Corbynomics from itself<p>Jeremy Corbyn’s stunning victory in the Labour leadership election has sparked much gnashing of teeth. Worryingly, it promises a testy political battle in the party at a time when the country needs an effective and viable opposition. </p>
<p>His brand of so-called Corbynomics has attracted a <a href="http://www.independent.co.uk/voices/comment/dont-be-fooled-by-utopian-corbynomics--it-is-seductive-fiction-10492000.html">fair amount of derision</a> in some quarters and <a href="http://www.ft.com/cms/s/0/49454d12-4a59-11e5-9b5d-89a026fda5c9.html#axzz3lKKkmFWO">benign tutting in others</a>. Nevertheless, there are some important elements in what he says that we believe are well grounded and which could now offer a clear, distinctive and viable economic programme with which to confront the government. </p>
<h2>Investment case</h2>
<p>Corbyn wants a public investment strategy to rebuild the UK’s economic capacity and ensure we can perform well as a competitive economy, with high wage and high-skilled jobs. This would ultimately be paid for by the long-term improvement in economic performance which investment makes possible, along with the improved tax receipts it generates. </p>
<p>The government would need to decide what balance to strike in using these receipts, between reducing future taxes, paying off national debt and making further investment in future economic capacity. Chancellor George Osborne has committed to prioritising <a href="https://uk.news.yahoo.com/jeremy-corbyn-vs-george-osborne-162252092.html#VfOU2v2">the first and second of these</a>; Corbyn would give more attention to the third. </p>
<p>Most economists would endorse this commitment to investment. Many, however, expect it to be forthcoming from the private sector, just as soon as the public sector shrinks enough to leave space for private sector initiative. This is also the chancellor’s position. </p>
<p>Corbyn instead follows economists from John Maynard Keynes to <a href="https://theconversation.com/profiles/mariana-mazzucato-185270">Mariana Mazzucato</a>, in arguing for a strong investment role for government as a condition for private investment to flourish.</p>
<h2>QE too?</h2>
<p>Corbyn has called for a version of “quantitative easing” by the Bank of England, as a means of financing this investment strategy. One attraction for Corbyn is that QE seems to be “costless”; it is just a matter of the bank printing money. This avoids making the deficit in public finances worse and undermining international confidence in the UK economy. </p>
<p>However, his investment strategy should in any case commend itself to the international financial markets, providing it is clearly separated from current account spending. Corbyn’s <a href="http://www.economist.com/news/britain/21660599-labours-prospective-next-leader-may-be-partys-hard-left-he-no-radical-jeremy">proposal for a National Development Bank</a> would be one way of doing this, without resorting to QE and without involving the Bank of England. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/94492/original/image-20150911-1575-22tvu6.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/94492/original/image-20150911-1575-22tvu6.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/94492/original/image-20150911-1575-22tvu6.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=249&fit=crop&dpr=1 600w, https://images.theconversation.com/files/94492/original/image-20150911-1575-22tvu6.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=249&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/94492/original/image-20150911-1575-22tvu6.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=249&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/94492/original/image-20150911-1575-22tvu6.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=313&fit=crop&dpr=1 754w, https://images.theconversation.com/files/94492/original/image-20150911-1575-22tvu6.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=313&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/94492/original/image-20150911-1575-22tvu6.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=313&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Notes and queries.</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/nataliejohnson/398006982/in/photolist-8PY4BV-hHH4en-qJESkB-hHFUYi-BaTBm-74gYSL-fFHJpA-BaTBp-p5WY7b-oeELth-owavWJ-oukqah-fqLDi-oeSyNm-ovTehk-ow8wZh-oxV9LH-93FNvj-93FRfj-93CCFF-93FEnE-93FGyY-93CMq6-93FFQu-93FPcw-pgWGgm-p6cgsN-oy8jxn-owaqF3-owahb7-ownASn-FriYz-pp7nTC-oeSKF1-93CDzn-93CAnT-93FKUd-93FQgu-93CyPX-93CGoR-93CEfH-93CH7X-DG8qi-dFjS11-fFr75F-b3f7X4-4of9ow-jDfgtM-DG83Y-5X2z6S">Natalie</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc/4.0/">CC BY-NC</a></span>
</figcaption>
</figure>
<p>His argument that QE is “costless” is misleading. The bank prints money (or rather creates it electronically) and uses this to buy government bonds (debt) on the financial markets. The aim is to drive down the general rate of interest, with the aim of stimulating private investment and economic growth. However, the government bonds that the Bank has bought mean that the Treasury still ends up owing it money (unless the Bank writes off the debt, something which would not be welcomed by the financial markets). </p>
<p>QE has already <a href="http://www.huffingtonpost.co.uk/adnan-aldaini/quantitative-easing_b_6692038.html">“cost” £375 billion</a>. Whatever the total outlay, it may have to be repaid in due course from taxation receipts, money which could otherwise be spent on hospitals and public services. </p>
<p>Corbyn may have misunderstood QE as “costless”, but the rest of the UK political class has been no less reticent about acknowledging the real cost of QE for the UK public.</p>
<h2>Tax avoidance</h2>
<p>The costs of QE represent only part of the cost of the financial crash of 2008. There was in addition the cost of bailing out banks such as Northern Rock, RBS and HBOS. The government has taken only modest steps to prevent a repeat of that disaster. It is unsurprising therefore that Corbyn has been able to tap into widespread public anger, with his plans to tackle corporate tax avoidance and banker bonuses. Corbyn cannot expect the UK to mount a successful attack on this front by itself. He would therefore be likely to support EU efforts to tackle these problems, rather than opposing them, as the chancellor has done. </p>
<p>There may also be merit in Corbyn’s wish to re-nationalise the railways. Standard economics allows for a case to be made for some economic activities to be undertaken by the state, where the social benefits of collective provision cannot be effectively realised by other means. <a href="https://theconversation.com/the-case-for-re-nationalising-britains-railways-45963">This may be one such case</a>, and one that can be successfully sold to voters. </p>
<p>Re-nationalisation would presumably however require compensation for investors – and this in turn would likely require higher taxes. That’s a tricky proposition for any government, but there is at least room for debate over where the tax burden should fall.</p>
<h2>‘You didn’t build that’</h2>
<p>Corbyn makes much of the benefits to the corporate sector of public activities, from the provision of roads to the education of tomorrow’s workers. His estimates of the overall value of this contribution <a href="http://www.thisismoney.co.uk/money/news/article-3182368/UK-sclerotic-failing-economy-Jeremy-Corbyn-Prime-Minister-warns-IoD-head.html">have been attacked</a>, but he is surely right that the business world and the public sector are intimately interrelated. This is very different from Osborne’s view that the public sector is a drag on private sector vitality and must accordingly be shrunk. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/94489/original/image-20150911-1544-1i9tmtx.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/94489/original/image-20150911-1544-1i9tmtx.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/94489/original/image-20150911-1544-1i9tmtx.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/94489/original/image-20150911-1544-1i9tmtx.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/94489/original/image-20150911-1544-1i9tmtx.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/94489/original/image-20150911-1544-1i9tmtx.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/94489/original/image-20150911-1544-1i9tmtx.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/94489/original/image-20150911-1544-1i9tmtx.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Duel carriageway.</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/45393120@N07/14073735004/">Highways England</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
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<p>Rather than decrying the ill-thought out nature of some of Corbyn’s proposals – others have done that already – we have tried to rescue the baby from the bath water and consider what a more workable statement of Corbynomics might involve, and how this might indeed appeal to a wider swathe of the electorate. </p>
<p>We have also sought to show some of the main areas of disagreement with current Conservative policy. This may enable a more balanced debate about the alternative ways forward for British economic policy.</p><img src="https://counter.theconversation.com/content/47381/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>There are some important parts of Corbynomics that can offer a clear, distinctive and viable economic programme with which to confront the government.Graham Room, Professor of European Social Policy, University of BathChris Martin, Professor of Economics, University of BathLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/313792014-09-05T11:05:34Z2014-09-05T11:05:34ZMore rational than radical – but Draghi’s Eurozone tactics leave something in the tank<figure><img src="https://images.theconversation.com/files/58333/original/g3hct9gn-1409908653.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Can Draghi the gambler feel Europe's pulse?</span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/dskley/9073960645/in/photolist-ePQqnk-5kdeCs-S3n1t-bth8sR-S1qBd-9VDqxo-8MjgtF-eQEbwt-4kuAZH-5BLiYj-4UjLxh-7kYC6b-eGDZWn-5Y96XW-81YsMF-ebc53i-6v4MLs-4YQaei-8QHYAe-aBA6JJ-7iffKj-eajSFq-2s2iJn-5FACeK-bZavU3-bJ3Fw8-9VDpCA-mEaCtu-ftvY8n-etXFBv-35Wdyj-cKZ9XY-cL4YxW-5gUZhL-bCe3Em-cGS5n1-hLyQmh-9tbt22-dUbnbk-cnfHKC-5RSz6R-a6KacU-cKZ9WN-7bwVgv-brpjFx-a9idKB-ceaaUm-4Z66Zz-aw43nf-514ovh">Dennis Skley</a>, <a class="license" href="http://creativecommons.org/licenses/by-nd/4.0/">CC BY-ND</a></span></figcaption></figure><p>The European Central Bank’s decision to <a href="http://www.theguardian.com/business/2014/sep/04/ecb-cuts-rates-help-eurozone-economies">cut its interest rates further</a> showed that the zero rate rubicon holds no fear, while one substantial bullet was kept in the barrel. It is a useful marker for markets of the lengths to which the ECB is willing to go as it wrestles with the Eurozone’s mess of political and economic imperatives.</p>
<p>In fact, while the main refinancing rate falls from 0.15% to 0.05%, the already negative -0.1% rate on deposits held with the ECB has moved to -0.2%. Official confirmation then that the once global taboo on zero nominal interest rate can now be considered just a point in a continuum of possible rates. This is good news. It allows markets to better form expectations consistent with the economic fundamentals, once the crisis-recession panic passes. </p>
<p>ECB president Mario Draghi’s announcement of the interest rate moves immediately <a href="http://www.reuters.com/article/2014/09/05/us-markets-global-idUSKBN0H001120140905">impacted the dollar value of the euro</a>, which from the onset of the US financial crisis had increased dramatically. <a href="http://www.xe.com/currencycharts/?from=EUR&to=USD&view=1W">Traders sent the euro down below $1.30</a> for the first time since July last year, and if the ECB moves happen in parallel with the US Federal Reserve’s <a href="https://theconversation.com/explainer-what-us-fed-tapering-means-for-markets-21639">tapering of its own stimulus measures</a>, the euro could head back to much lower, pre-crisis levels. This could imply higher input prices, with some – long awaited by many – inflationary pressures, but also more competitiveness for the Eurozone goods and services.</p>
<h2>Debt management</h2>
<p>At the same time the ECB has shown its determination to proceed with potentially massive refinancing of the banking sector and has left open the possibility of buying up government debt, another policy traditionally viewed as taboo, as least in the main core of the Eurozone.</p>
<p>In the Eurozone, the unemployment rate has increased pretty steadily <a href="http://epp.eurostat.ec.europa.eu/statistics_explained/index.php/Unemployment_statistics">from less than 7.5% in 2008 to 11.5% in 2014</a>. At the same time, public debt has increased on average from about 67% of GDP in 2008 to more than 93% of GDP in 2014. Both statistics increased by nearly 50% in this period.</p>
<p>This means that last weapon in Draghi’s arsenal is a useful one to have in reserve. That sharp increase in public debt levels, of 26 percentage points, represents the additional money Eurozone governments now owe to creditors, and by extrapolation, what Eurozone taxpayers will eventually have to stump up. They would love the idea of having to pay a very low interest on the debts governments have piled up in the past 6 years.</p>
<p>So what would have happened if a more accommodating ECB monetary policy had allowed government debts to remain constant at their 2008 levels? This would have probably meant more inflation than we have now, but also that government liabilities (debt) of the order of one quarter of GDP would not have accumulated. Taxpayers would not have had to worry about that extra burden at all. Such thoughts make it tempting to recommend some bravery now on the part of the ECB in the form of wholesale quantitative easing to buy up that government debt, maybe posing clear constraints on governments not to abuse the privilege. However, the current level of political maturity in the Euro area probably suggests a more gradual and moderate approach, which is why we get the useful but restrained ECB moves that we have seen this week.</p>
<h2>A political economy</h2>
<p>The ECB’s latest decisions have continuity with its previous actions and with its (more or less) openly declared strategy. In fact, after <a href="http://online.wsj.com/articles/german-gdp-contraction-confirmed-for-second-quarter-1409552979">German GDP contracted by 0.2%</a> in the second quarter – coupled with a long-term contraction in Italy which has seen GDP fall by 8% since 2008 – it became clear that something had to be done to reassure the markets. Job done there, it seems, <a href="http://www.ft.com/cms/s/0/f0fec07c-343b-11e4-8832-00144feabdc0.html#axzz3CQuuxDMa">as the consensus appears to be a welcome</a> for the measures from market players.</p>
<p>It is worth remembering the context for Draghi’s decision-making before we become too focused on the economic imperatives. Europe has an increasingly important role to play, especially considering the serious social, political, and military tensions which surround it. The Ukraine-Russia tensions were mentioned as a key factor in explaining the German contraction. The turmoil in North-Africa and Middle East, with its desperate massive migration towards the other shore of the Mediterranean sea is exacerbating the tensions related to the mass youth unemployment in Italy, now above 42%.</p>
<p>Given the more and more crucial role that Europe has to play in the surrounding regions, the ECB’s brand of credible but restrained and reactive guidance and action could be its greatest strength. In fact, it is little short of amazing that its central bankers have been able to conciliate the different positions, interests, and preoccupations of its diverse members. The Eurozone is indeed heterogeneous, but this should, and appears to, add to its strengths. Finding an acceptable compromise between different positions is the art of navigating political and economic markets. In Mario Draghi, it seems to have a capable captain.</p><img src="https://counter.theconversation.com/content/31379/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Guido Cozzi does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The European Central Bank’s decision to cut its interest rates further showed that the zero rate rubicon holds no fear, while one substantial bullet was kept in the barrel. It is a useful marker for markets…Guido Cozzi, Professor of Macroeconomics, University of St.GallenLicensed as Creative Commons – attribution, no derivatives.