tag:theconversation.com,2011:/uk/topics/quantitative-easing-qe-3842/articlesQuantitative easing (QE) – The Conversation2024-02-26T17:19:21Ztag:theconversation.com,2011:article/2240922024-02-26T17:19:21Z2024-02-26T17:19:21ZWhy economists are warning of another US banking crisis<p>March 2024 is <a href="https://www.barrons.com/articles/nycb-bank-failures-fed-btfp-0798fa18">making investors nervous</a>. A major scheme to prop up the US banking system is ending, while a second may be winding down. <a href="https://tavexbullion.co.uk/finnish-economist-who-predicted-the-spring-banking-crisisnew-bank-runs-are-coming/">Some economic commentators fear</a> another banking crisis. So how worried should we be?</p>
<p>The red letter day is March 11, when US central bank the Federal Reserve will end the <a href="https://www.investopedia.com/bank-term-funding-project-7367897">bank term funding program (BTFP)</a>, a year after it began in response to the failures of regional banks Signature, Silvergate and Silicon Valley. These banks were brought down by customers withdrawing deposits en masse, both because many were tech or crypto businesses that needed money to cover losses, and because there were better savings rates available elsewhere. </p>
<p>This damaged the banks’ profitability at a time when raised interest rates had already weakened their balance sheets by reducing the value of their holdings in government bonds. Silvergate failed first but Silicon Valley Bank’s collapse on March 10 was particularly memorable. It triggered a bank run <a href="https://www.reuters.com/business/finance/silicon-valley-bank-sell-stock-cope-with-cash-burn-2023-03-09/">by announcing</a> it needed to raise capital after being forced to sell bonds at a loss. </p>
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<a href="https://images.theconversation.com/files/577942/original/file-20240226-28-jfojgh.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Screenshot of WSJ's front cover when Silicon Valley collapsed" src="https://images.theconversation.com/files/577942/original/file-20240226-28-jfojgh.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/577942/original/file-20240226-28-jfojgh.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=442&fit=crop&dpr=1 600w, https://images.theconversation.com/files/577942/original/file-20240226-28-jfojgh.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=442&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/577942/original/file-20240226-28-jfojgh.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=442&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/577942/original/file-20240226-28-jfojgh.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=556&fit=crop&dpr=1 754w, https://images.theconversation.com/files/577942/original/file-20240226-28-jfojgh.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=556&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/577942/original/file-20240226-28-jfojgh.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=556&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">Silicon Valley Bank’s demise put investors on high alert.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/march-10-2023-silicon-valley-bank-2274268829">Domenico Fornas</a></span>
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<p>There soon followed the failures <a href="https://www.forbes.com/sites/brianbushard/2023/03/13/what-happened-to-signature-bank-the-latest-bank-failure-marks-third-largest-in-history/">of Signature</a> and also Swiss bank <a href="https://edition.cnn.com/2023/04/24/investing/credit-suisse-bank-withdrawals-total/index.html">Credit Suisse</a>, which had to be taken over by <a href="https://www.ubs.com/global/en/media/display-page-ndp/en-20230612-ubs-credit-suisse-acquisition.html">neighbouring giant UBS</a>. There had been longstanding problems at Credit Suisse, but heightened anxieties on the back of the US upheaval delivered the final blow. </p>
<h2>How the BTFP works</h2>
<p>Investors then feared that other banks would fail. Most US banks were similarly exposed to customer withdrawals and underwater bond portfolios, while the Credit Suisse collapse demonstrated the potential for contagion. The Fed’s BTFP stopped the panic by allowing US banks to borrow from the central bank using their bonds as collateral. </p>
<p>Not only did this let them quietly access more funding, the scheme also priced the bonds at their original face value and not market value. This effectively negated the interest rate rises and reinflated banks’ balance sheets. Only one more bank, San Francisco’s <a href="https://www.forbes.com/sites/dereksaul/2023/05/01/first-republic-bank-failure-a-timeline-of-what-led-to-the-second-largest-bank-collapse-in-us-history/">First Republic Bank</a>, has since gone under. </p>
<p>So what will happen as the BTFP closes? I suspect it won’t lead to more bank collapses. Banks have had another year to adjust to higher interest rates, plus they can still borrow from the Fed through another facility called the <a href="https://www.investopedia.com/terms/d/discountwindow.asp">discount window</a>. </p>
<p>Nonetheless, the BTFP’s closure is <a href="https://www.bloomberg.com/news/articles/2023-12-21/demand-for-fed-s-bank-term-funding-facility-grows-to-record-high">likely to increase</a> banks’ borrowing costs, meaning their profit margins will fall. They might react with higher lending rates or by making less credit available to customers, potentially weakening the economy. This could combine with a second foreseeable change to create new dangers for the sector. </p>
<h2>Quantitative tightening</h2>
<p>That second change relates to the <a href="https://theconversation.com/why-central-banks-are-too-powerful-and-have-created-our-inflation-crisis-by-the-banking-expert-who-pioneered-quantitative-easing-201158">quantitative easing (QE) programme</a> by the Fed and other central banks, which broadly dates from the global financial crisis of 2007-09. It saw central banks essentially creating new money and using it to buy government bonds and other financial assets. They added more reserves to high-street banks as part of this process, enabling these institutions to lend more money as a result. </p>
<p>The most recent leg of QE <a href="https://www.brookings.edu/articles/fed-response-to-covid19/">began in March 2020</a> in response to the pandemic, then ended in 2022, when central banks began a reverse programme called quantitative tightening (QT). This involves selling bonds and other assets and removing the proceeds from the financial system. </p>
<p>It should be a drag on the economy, yet the effects have been tempered by a facility known as the overnight reverse repurchase agreement or “overnight reverse repo”. This essentially enables financial institutions to deposit their excess cash overnight with their central bank in exchange for government bonds. They earn extra money at very low risk, injecting more liquidity into the system. </p>
<p>The facility was extremely popular during the period of QE and ultra-low interest rates because these injected so much cash into the system. Its use <a href="https://www.reuters.com/markets/rates-bonds/new-york-fed-inflows-reverse-repo-facility-surge-hitting-1018-trillion-2023-12-29/#:%7E:text=The%20facility%20has%20seen%20big,30%2C%202022.">has been falling</a> since late 2022, since central banks have fewer bonds to lend while institutions have less money to park overnight. </p>
<p>Daily balances at the Fed’s overnight reverse repo <a href="https://www.reuters.com/markets/us/focus-sharpens-feds-disappearing-reverse-repo-mcgeever-2024-01-17/">have fallen</a> from over US$2.2 trillion (£1.7 trillion) in mid-2023 to below US$600 billion in January. However, while the positive balance continues, it offsets the need for the Fed to remove bank reserves as part of QT, since the bonds flowing out under that scheme are being partially replaced by bonds flowing in through the overnight reverse repo. </p>
<p>Only when the reverse repo balance reaches very low levels will the system feel the full effect of QT. At this stage, the Fed <a href="https://www.fitchratings.com/research/sovereigns/federal-reserve-to-continue-running-down-assets-until-end-2024-15-02-2024">has indicated</a> it will slow and then end that programme. </p>
<p>Nonetheless, the transition could be bumpy, with banks potentially raising lending rates and becoming less willing to lend. Many analysts expect the buffer to disappear in 2024, with a range of predictions from <a href="https://www.fitchratings.com/research/sovereigns/federal-reserve-to-continue-running-down-assets-until-end-2024-15-02-2024">late in the year</a> to as <a href="https://cryptohayes.medium.com/signposts-693ba565cd3e">soon as March</a>. </p>
<h2>Risky times</h2>
<p>Heightened interest rates <a href="https://www.federalreserve.gov/data/sloos/sloos-202401.htm">have already led</a> to the most stringent credit standards and weakest loan demand from consumers and businesses in a long time in the US. Meanwhile, banks are dealing with other major challenges such as the plunge in demand for office space as a result of home working. This has brought the medium-sized <a href="https://www.reuters.com/markets/us/real-estate-pain-us-regional-banks-is-piling-up-say-investors-2024-02-12/">New York Community Bank</a> to the brink in recent weeks, for instance. </p>
<p>The closure of the BTFP and the end of the reverse repo buffer, particularly if they coincide, could clearly make banks even more risk averse and profit-hungry. The danger is that this all damages the economy to the point that bad debts pile up and we hit another 2008-style liquidity crisis where banks become wary of lending to one another and the weaker ones become unviable. </p>
<p>The recent geopolitical tensions are an additional danger. If cross-border credit and investments dried up, it might further increase the risks of bad debts and could again hit bond prices, further reducing the value of banks’ assets and making their borrowing more expensive. </p>
<p>The Fed and other central banks need to be alert to these rising risks and get ready to end QT in the near future. The end of the BTFP is unlikely to put banks out of business, but it could be one of a series of blows that kicks off a new crisis in the months ahead.</p><img src="https://counter.theconversation.com/content/224092/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Ru Xie 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 Ides of March will coincide with one or two changes to the financial system that could cause problems for banks and the economy.Ru Xie, Associate Professor in Finance, University of BathLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2139922023-11-08T19:10:37Z2023-11-08T19:10:37ZIs capitalism dead? Yanis Varoufakis thinks it is – and he knows who killed it<p><a href="https://www.yanisvaroufakis.eu/">Yanis Varoufakis</a> grew up during the Greek dictatorship of 1967-1974. He later became an economics professor and was briefly Greek finance minister in 2015.</p>
<p>His late father, a chemical engineer in a steel plant, instilled in his son a critical appreciation of how technology drives social change. He also instilled him with a belief that capitalism and genuine freedom were antithetical – a leftist politics that made his father a political prisoner for several years during the “junta”, as they called it.</p>
<p>In 1993, when he first got the internet, Varoufakis’s father posed a “killer question” to his son: “now computers speak to each other, will this network make capitalism impossible to overthrow? Or might it finally reveal its Achilles heel?” </p>
<p>Varoufakis has been mulling it over ever since. </p>
<p>Though, sadly, it is now too late to explain to his father in person, Varoufakis’s new book <a href="https://www.penguin.com.au/books/technofeudalism-9781847927286">Technofeudalism: What Killed Capitalism</a> answers the question in the form of an extended reflection addressed to his father.</p>
<p>“Achilles heel” was on the right track. In his striking response, Varoufakis argues that we no longer live in a capitalist society; capitalism has morphed into a “technologically advanced form of feudalism”.</p>
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<p><em>Review: Technofeudalism: What Killed Capitalism – Yanis Varoufakis (Bodley Head)</em></p>
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<h2>Rent over profit</h2>
<p>Traditional capitalists are people who can use capital – defined as “anything that can be used to produce saleable goods” (such as factories, machinery, raw materials, money) – to coerce workers and generate income in the form of profits. Such capitalists are clearly still flourishing, but Varoufakis argues they are not driving the economy in the way they used to. </p>
<p>“In the early 19th century,” <a href="https://www.project-syndicate.org/commentary/techno-feudalism-replacing-market-capitalism-by-yanis-varoufakis-2021-06">he writes</a>, </p>
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<p>many feudal relations remained intact, but capitalist relations had begun to dominate. Today, capitalist relations remain intact, but techno-feudalist relations have begun to overtake them.</p>
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<p>Traditional capitalists, he proposes, have become “vassal capitalists”. They are subordinate and dependent on a new breed of “lords” – the Big Tech companies – who generate enormous wealth via new digital platforms. A new form of algorithmic capital has evolved – what Varoufakis calls “cloud capital” – and it has displaced “capitalism’s two pillars: markets and profits”. </p>
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<p>Markets have been “replaced by digital trading platforms which look like, but are not, markets”. The moment you enter amazon.com “you exit capitalism” and enter something that resembles a “feudal fief”: a digital world belonging to one man and his algorithm, which determines what products you will see and what products you won’t see. </p>
<p>If you are a seller, the platform will determine how you can sell and which customers you can approach. The terms in which you interact, share information and trade are dictated by an “algo” that “works for [Jeff Bezos’] bottom line”. </p>
<p>The capitalists who rely on this mode of selling are granted access to the digital estate by its virtual landowners, the Big Tech companies. And if “vassal capitalists” don’t abide by the laws of the estate, they are kicked out – removed from Apple’s App Store or Google’s search index – with disastrous consequences for their business. </p>
<p>Access to the “digital fief” comes at the cost of exorbitant rents. Varoufakis notes that many third-party developers on the Apple store, for example, pay 30% “on all their revenues”, while Amazon charges its sellers “35% of revenues”. This, he argues, is like a medieval feudal lord sending round the sheriff to collect a large chunk of his serfs’ produce because he owns the estate and everything within it.</p>
<p>This is not extracting profit through the production or provision of goods and services, as these platforms are not a “service” in the sense in which the term is used in economics. They are extracting rents in the form of the huge cuts they take from the capitalists on their platforms.</p>
<p>There is “no disinterested invisible hand of the market” here. The Big Tech platforms are exempted from free-market competition. Their owners – “cloudalists” – increase their wealth and power at a dizzying pace with each click, exploiting a new form of rent-seeking made possible by the new algorithmically structured digital platforms. Parasitic on capitalist production, they are now dominating it. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/yanis-varoufakis-from-accidental-economist-to-finance-minister-36827">Yanis Varoufakis: from accidental economist to finance minister</a>
</strong>
</em>
</p>
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<h2>Cloud serfs</h2>
<p>But something even more transformative has happened, Varoufakis argues.</p>
<p>Even though most of us are regularly interacting with capitalists and earning wages via our labour, now, for the first time in history, all of us contribute to “the wealth and power of the new ruling class” through our “unpaid labour”. </p>
<p>Every time we use our cloud-linked devices – smartphones, laptops, Alexa, Google Assistant, Siri – we replenish the capital of the Big Tech cloudalists. This in turn increases their capacity to generate more wealth. How? We train their algorithms, which train us, to train them, and so on, in a feedback loop whose goal is to shape our desires and behaviour. They are “selling things to us while selling our attention to others”. </p>
<p>This interaction, Varoufakis insists, is not taking place as any kind of market exchange, such as wages being paid by a capitalist to a group of workers. In this interaction, we are all high-tech “cloud serfs”. </p>
<p>The new advertising men of the postwar world, portrayed in the series Mad Men (Yanis is clearly a fan), thought television was amazing because of its power to deliver audiences to advertisers. They could innovate “attention-grabbing” ways of “manufacturing” consumer desires – and it was delivered free-to-air! </p>
<p>But, Varoufakis emphasises, the ad men of the previous century could never have imagined the development of something like Amazon’s Alexa: a digital network learning “at lightning speed”, via the input of millions of people, how to train us. It is shaping our desires and behaviours in a process of perpetual reinforcement. Our experience and reality are increasingly algorithmically curated. And due to the incredible ease and utility, the information is all freely given. </p>
<p>So the “cloud capital” we are generating for them all the time increases their capacity to generate yet more wealth, and thus increases their power – something we have only begun to realise. Approximately 80% of the income of traditional capitalist conglomerates go to salaries and wages, according to Varoufakis, while Big Tech’s workers, in contrast, collect “less than 1% of their firms’ revenues”.</p>
<h2>Quantitative easing</h2>
<p>So how did this dystopian turn happen without us really noticing the change? Varoufakis’s story is detailed, but he emphasises two main drivers.</p>
<p>First, the “internet commons” of Web 1.0 transformed into Web 2.0, privatised by American and Chinese Big Tech.</p>
<p>Second, the colossal sums of central bank money that were supposed to refloat our economies in the aftermath of the 2008 Global Financial Crisis (GFC) – a process known as “<a href="https://theconversation.com/more-money-more-problems-the-quantitative-easing-quandary-9758">quantitative easing</a>” – were lent out to big business. Coupled with “austerity” economics for the many, this “murder[ed] investment” and led to what Varoufakis calls “gilded stagnation”. </p>
<p>Much of the central bank money, particularly following another round of quantitative easing during the COVID pandemic, made its way to the Big Tech companies. Their share prices soared to astronomical levels. </p>
<p>The “world of money” was decoupled from the “real economy” where most of us live and work. In an environment where profit became “optional”, loss-making Big Tech companies run by “intrepid and talented entrepreneurs” chose to build up their cloud capital. </p>
<p>So along with markets being steadily replaced by digital platforms, central bank money displaced private profits as the fuel that “fire[s] the global economy’s engine”. Intended by G7 central bankers and their presidents and prime ministers to “save capitalism”, it has unintentionally helped finance the emergence of a new form of capital (cloud capital) and a “new ruling class”. </p>
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<a href="https://images.theconversation.com/files/554466/original/file-20231018-23-rnfwr0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/554466/original/file-20231018-23-rnfwr0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/554466/original/file-20231018-23-rnfwr0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/554466/original/file-20231018-23-rnfwr0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/554466/original/file-20231018-23-rnfwr0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/554466/original/file-20231018-23-rnfwr0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/554466/original/file-20231018-23-rnfwr0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/554466/original/file-20231018-23-rnfwr0.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">The ‘world of finance’, argues Yanis Varoufakis, has decoupled from the ‘real economy’</span>
<span class="attribution"><span class="source">Markus Spiske/Unsplash</span></span>
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<h2>GFC: the turning point</h2>
<p>So why was the GFC such a pivotal point? Varoufakis has a lot to say. Here’s a brief sketch. (Bear with me!)</p>
<p>Crucial changes had taken place in our economies since the rise of large corporations in industry and banking, which grew ever bigger over the course of the 20th century, eventually becoming global in scale. </p>
<p>The Bretton Woods international financial system – designed to prevent the “greed-fuelled recklessness” that led to the 1929 crash, the Great Depression and a world war – was abolished in 1971. From the 1970s, economies were progressively deregulated and free-market policies were increasingly enthusiastically practised, leading to a new “financialised” version of capitalism.</p>
<p>This was facilitated by the suppression of workers’ wages and bargaining power. The weakened state was progressively captured by lobbyists for the interests of big business. And the hegemony of the US dollar in the global system led to a “tsunami” of dollars pouring back into US markets from Europe, Japan, and later China, “[enriching] America’s ruling class, despite its [large trade] deficit”. </p>
<p>By the new millennium, this had led to an orgy of speculation and, by 2007, the financiers, using “computer-generated complexity” to obscure the “gargantuan risks”, had “placed bets worth ten times more than humanity’s total income”.</p>
<p>The new version of capitalism was failing. But it had grown to such scale and in such a complex, integrated “globalised” way that the banks and insurance companies were “too big to fail”. Their collapse in 2008 would have taken down the US banking system, and the rest of the world with it. Their hubris was thus “rewarded with massive state bailouts”.</p>
<p>What <em>could</em> have happened, as in <a href="https://www.rferl.org/a/Explainer_How_Sweden_Rescued_Banks_1990s/1379859.html">Sweden in the 1990s</a>, was to “kick out” the bankers, nationalise the banks, appoint new directors and, years later, sell them to new owners – thus saving the banks, but not the bankers.</p>
<p>What happened instead was that bankers, handed large bailouts, did not direct the money to where it was most needed. Neither punished nor chastened, they sent it straight to Wall Street. And there it stayed. Combined with the profits sent to Wall Street from the rest of the world, it eventually caused an “everything rally” that went on for over a decade. </p>
<p>This ultimately helped fuel the development of the cloud capital that has overtaken capitalism. And every time we use our devices, we contribute to its value. The more we transact via platforms, the further we move away from an economic system primarily driven by markets and profits, and the more power concentrates “in the hands of even fewer individuals” – a “tiny band of multi-billionaires residing mostly in California or Shanghai”.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/greed-is-amoral-how-wall-street-supermen-cashed-in-on-pandemic-misery-and-chaos-207311">'Greed is amoral': how Wall Street supermen cashed in on pandemic misery and chaos</a>
</strong>
</em>
</p>
<hr>
<h2>A tech-driven economic revolution</h2>
<p>Varoufakis suggests his theory helps us better understand extreme wealth inequalities, the “atrophied democracies” and “poisoned politics” of the West, geopolitics (he interprets the United States and China as two rival “super cloud fiefs”), the stalling of the green energy revolution, and more.</p>
<p>For Varoufakis, we are not just living through a tech revolution, but a tech-driven economic revolution. He challenges us to come to terms with just what has happened to our economies – and our societies – in the era of Big Tech and Big Finance.</p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/558188/original/file-20231107-19-nr1728.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/558188/original/file-20231107-19-nr1728.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/558188/original/file-20231107-19-nr1728.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=935&fit=crop&dpr=1 600w, https://images.theconversation.com/files/558188/original/file-20231107-19-nr1728.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=935&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/558188/original/file-20231107-19-nr1728.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=935&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/558188/original/file-20231107-19-nr1728.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1175&fit=crop&dpr=1 754w, https://images.theconversation.com/files/558188/original/file-20231107-19-nr1728.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1175&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/558188/original/file-20231107-19-nr1728.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1175&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>
</figcaption>
</figure>
<p>The first decades of the 21st century have brought challenges that we are still struggling to come to grips with. One thing is for sure – we have no hope of improving things without properly understanding our predicament. </p>
<p>This book is a welcome contribution towards that task. A technofeudalist age, Varoufakis argues, is not inevitable. Despite the difficulties we face, we have the agency to reject “techno dystopia” and structure our institutions in ways that more meaningfully embody freedom and democracy.</p>
<p>Towards the end of Technofeudalism, Varoufakis canvasses some proposals, drawn from his earlier book <a href="https://www.penguin.com.au/books/another-now-9781529110630">Another Now</a> (2020), for how to address these issues. These include ending the cloudalists faux “free service” model and replacing it with a universal micro-payment model, instituting a Bill of Digital Rights, and using digital technology to “democratise companies” (with decisions being taken collectively by “employee-shareholders”).</p>
<p>Varoufakis also proposes to “democratise money”. This plan would involve central banks issuing digital wallets, a universal basic income, reconfiguring “the central bank’s ledger” in the direction of a “common payment and savings system”, and abolishing the current capacity of private banks to “create money”.</p>
<p>The proposals are pretty radical, but I think Varoukais would say they are as radical as the times require them to be.</p><img src="https://counter.theconversation.com/content/213992/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Christopher Pollard 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>Traditional capitalists are still flourishing, but according to Yanis Varoufakis they are not driving the economy like they used to.Christopher Pollard, Tutor in Sociology and Philosophy, Deakin UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2029882023-04-12T11:17:42Z2023-04-12T11:17:42ZFour reasons inflation will stay stubbornly high for some time<figure><img src="https://images.theconversation.com/files/519560/original/file-20230405-18-q27586.jpg?ixlib=rb-1.1.0&rect=0%2C0%2C6079%2C3394&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Climbing inflation.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/development-attainment-motivation-career-growth-concept-1029299632">Sergey Tinyakov/Shutterstock</a></span></figcaption></figure><p>Price inflation is <a href="https://www.theguardian.com/business/live/2023/mar/30/green-shoots-hopes-uk-economy-core-inflation-us-gdp-energy-strategy-business-live#:%7E:text=Inflation%20in%20Spain%20has%20tumbled,Spanish%20inflation%20dropped%20to%203.1%25.">starting to fall</a> in many countries but it still remains way above the typical <a href="https://www.bankofengland.co.uk/monetary-policy/inflation">2% target of most major economies</a>. In the UK, inflation has been <a href="https://commonslibrary.parliament.uk/research-briefings/cbp-9428/#:%7E:text=The%20cost%20of%20living%20increased,2023%20to%2010.4%25%20in%20February.">above target</a> since August 2021 and in <a href="https://www.economist.com/graphic-detail/2022/08/17/british-inflation-hits-double-digits">double digits</a> since August 2022.</p>
<p>In 2021, I was <a href="https://theconversation.com/rising-inflation-unless-we-act-now-it-will-not-be-temporary-168106">one of the economists who warned</a> that high inflation might not be “transient”, as major central and various think tanks were <a href="https://www.afr.com/policy/economy/why-central-banks-got-inflation-so-wrong-20220907-p5bg4w">claiming at the time</a> when they said rapid price rises wouldn’t last long. I argued for action before high inflation became embedded in the economy and <a href="https://www.bbc.co.uk/news/business-your-money-65079792">made the UK a poorer country</a>. </p>
<p>Unfortunately, <a href="https://news.sky.com/story/uk-economy-to-fare-worse-than-any-other-country-in-developed-world-this-year-imf-forecasts-12799201">this has now happened</a>. And while I believe inflation will start falling from current highs soon, it’s going to be tough to bring it back to <a href="https://www.bankofengland.co.uk/monetary-policy/inflation">the government’s 2% target</a>.</p>
<p>Central banks <a href="https://www.theguardian.com/business/2023/jan/09/bank-of-england-high-inflation-could-last-longer-than-expected-chief-economic-energy-prices-uk-recession">often point to</a> the war in Ukraine and spiking energy prices when explaining recent rapid price rises. But US and UK inflation was already at <a href="https://news.sky.com/story/us-inflation-hits-fresh-four-decade-high-even-before-ukraine-war-added-to-price-pressures-12562618">a four-decade high</a> before the start of the war. The truth is that the global economy is now entering a period of permanently higher inflation fuelled by four deeper forces.</p>
<h2>1. ‘De-globalisation’</h2>
<p>One of the long-term drivers of inflation is an economic cold war. The Trump administration in the US led initial efforts to <a href="https://observer.com/2017/03/protectionism-could-it-benefit-us-economy-free-trade-wto-useconomy/">impose trade sanctions against China</a> and the current administration seems <a href="https://www.forbes.com/sites/miltonezrati/2022/12/25/biden-escalates-the-economic-war-with-china/?sh=3a2e5eec12f3">even more determined</a> to end US reliance on Chinese products. The economic relationship between the west and Russia –- a major global exporter of energy and commodities – has entered a similar period of decline. </p>
<p>And this reversal of globalisation is not limited to international relationships. Politicians often <a href="https://blogs.lse.ac.uk/europpblog/2021/09/01/what-economic-nationalism-is-and-what-it-is-not/">promise to protect</a> jobs, rejuvenate industries and reduce national trade deficits by weakening the local economy’s global ties. They do this with higher tariffs and bureaucratic costs, and by subsidising national industries. </p>
<p>This can fail to account for retaliation by the affected countries, however, which squeezes markets, making goods more expensive and boosting inflation. Politicians should be honest about the potential impact of these decisions <a href="https://observer.com/2017/03/protectionism-could-it-benefit-us-economy-free-trade-wto-useconomy/">on domestic prices</a>.</p>
<p>With Brexit, for example, <a href="https://www.bbc.co.uk/news/uk-politics-eu-referendum-36086987">UK politicians promised</a> all the benefits of a unified European market without any of the obligations. Unsurprisingly, the EU retaliated by reducing UK access to its market. The result was <a href="https://www.theguardian.com/business/2022/dec/03/brexit-has-fuelled-surge-in-uk-food-prices-says-bank-of-england-policymaker#:%7E:text=there%20were%20clear%20signs%20leaving%20the%20EU%20was%20adding%20to%20soaring%20prices">higher prices</a>, <a href="https://edition.cnn.com/2022/12/24/economy/brexit-uk-economy/index.html">reduced investment</a>, <a href="https://www.theguardian.com/politics/2023/jan/17/shortfall-of-330000-workers-in-uk-due-to-brexit-say-thinktanks">workforce cuts</a>, and ultimately <a href="https://www.independent.co.uk/news/uk/politics/brexit-cost-uk-gdp-economy-failure-b2246610.html">a lower GDP path</a> for all involved – but chiefly for the UK. </p>
<h2>2. Climate change</h2>
<p>The recent “<a href="https://www.reuters.com/business/retail-consumer/uk-government-calls-supermarket-bosses-salad-crisis-talks-2023-02-27/">salad crisis</a>” saw shortages cause food prices spikes. This will not be a one-off. Weather is increasingly <a href="https://www.carbonbrief.org/mapped-how-climate-change-affects-extreme-weather-around-the-world/">unstable</a>, hindering production and even making <a href="https://www.oxfam.org/en/5-natural-disasters-beg-climate-action">natural disasters</a> more likely.</p>
<p>Like <a href="https://www.webmd.com/covid/news/20220912/climate-change-pandemics-more-common#:%7E:text=Increase%20of%20Other%20Pandemics,due%20to%20temperature%20and%20rainfall">pandemics</a>, these events disrupt production and can be costly for businesses to manage and overcome. Increased costs are passed on to consumers, as are the costs of <a href="https://blogs.worldbank.org/allaboutfinance/inflation-and-ecological-transition-european-perspective">government initiatives</a> such as carbon taxes.</p>
<h2>3. Wage-price spiral</h2>
<p>Central banks have been widely criticised for failing to act on inflation earlier and allowing a wage-price spiral to fuel further price inflation. This is when high inflation pushes up wages, which then boosts demand and spending, leading to more inflation. It’s a vicious circle that affects service-based economies (like the UK) the worst.</p>
<p>Recent <a href="https://www.cnbc.com/2023/02/01/uk-strikes-half-a-million-brits-are-taking-part-in-the-biggest-walkout-for-12-years.html">worker strikes</a> in the UK and <a href="https://www.piie.com/blogs/realtime-economics/us-workers-wage-gains-2023-are-likely-exceed-inflation">the quick pace of US salary rises</a> are not just a predictable reaction to high inflation, they also strengthen it. The wage-price spiral could push inflation higher for a long time unless addressed. </p>
<figure class="align-center ">
<img alt="Close-up of a gauge marked with a shopping trolley and low, medium high; pointer at high." src="https://images.theconversation.com/files/519098/original/file-20230403-24-zn7jv1.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/519098/original/file-20230403-24-zn7jv1.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=371&fit=crop&dpr=1 600w, https://images.theconversation.com/files/519098/original/file-20230403-24-zn7jv1.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=371&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/519098/original/file-20230403-24-zn7jv1.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=371&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/519098/original/file-20230403-24-zn7jv1.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=466&fit=crop&dpr=1 754w, https://images.theconversation.com/files/519098/original/file-20230403-24-zn7jv1.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=466&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/519098/original/file-20230403-24-zn7jv1.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=466&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">High-price inflation is affecting the cost of food.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-illustration/3d-illustration-key-performance-indicator-needle-1893009988">Olivier Le Moal/Shutterstock</a></span>
</figcaption>
</figure>
<h2>4. Highly liquid global markets</h2>
<p>Liquidity is the amount of money that exists in an economy. Following the 2008 global financial crisis, central banks pumped more money into major economies through a convoluted process called quantitative easing (QE). </p>
<p>What started as a reasonable measure to shore up the banking sector and help households and businesses via low interest rates became an addictive habit in the 2010s. QE liquidity is now <a href="https://www.bankofengland.co.uk/monetary-policy/quantitative-easing#:%7E:text=In%20turn%2C%20that%20increases%20how,billion%20were%20UK%20corporate%20bonds">equal to 40% of GDP</a> in the US and UK.</p>
<p><a href="https://www.economicshelp.org/blog/797/economics/why-printing-money-causes-inflation/#:%7E:text=If%20the%20money%20supply%20increases,firms%20to%20put%20up%20prices.">Economic theory</a> suggests such extreme liquidity would cause inflation. While this <a href="https://www.investopedia.com/articles/investing/022615/why-didnt-quantitative-easing-lead-hyperinflation.asp">didn’t happen</a>, it has created problems for the global economy. </p>
<p>QE boosted the valuation of all assets. From real estate to shares, art and even Bitcoin, we are now in an “<a href="https://fortune.com/2023/01/07/forecasts-gone-wrong-wall-street-bitcoin-stock-market-everything-bubble/">everything bubble</a>”. This has not only <a href="https://www.theguardian.com/inequality/2017/nov/14/worlds-richest-wealth-credit-suisse">increased inequality</a>, but has also affected how central banks fight inflation. Sustained high interest rates could bankrupt households, businesses or even whole countries that borrowed when rates were low. <a href="https://www.theguardian.com/business/2023/mar/13/silicon-valley-bank-collapse-central-banks-interest-rate-rises">Recent bank collapses</a> are a stark warning that central banks are limited in how much they can use rate rises to fight inflation. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/silicon-valley-bank-how-interest-rates-helped-trigger-its-collapse-and-what-central-bankers-should-do-next-201697">Silicon Valley Bank: how interest rates helped trigger its collapse and what central bankers should do next</a>
</strong>
</em>
</p>
<hr>
<h2>Solutions to persistently high inflation</h2>
<p>The current situation makes it difficult for central banks and governments to fight inflation. If interest rates rise further to subdue inflation and then remain elevated for a long time, households, pension funds, banks, stock markets and possibly even governments could collapse as they struggle to afford rising rates on loans such as mortgages. This means that interest rate changes – one of the main tools used to fight inflation – has potentially lost its edge and credibility. </p>
<p>Unfortunately there are rarely any miracle solutions in economics, but working to address these deeper causes of inflation will help bring inflation back towards the government’s 2% target. </p>
<p>Environmental degradation and its impact on inflation relies on change by governments, businesses and consumers. A thoughtful migration policy could alleviate shortages of people and skills, boost production and keep inflation lower. The impact of trade wars on GDP could be addressed through investment in technology, people and infrastructure. Reversing acts of economic self-harm such as Brexit and other forms of economic nationalism could also play a role: our politicians also need to be honest about the impact of different choices on local businesses and people. </p>
<p>Overall, it’s important to prevent longer-term damage from this period of high inflation, rising interest rates and uncertainty. Vulnerable groups that tend to be more deeply affected by price rises should be protected. While this won’t bring inflation down in the short term, it will make the cost of living crisis easier for more people and businesses to navigate while these deeper causes are addressed.</p><img src="https://counter.theconversation.com/content/202988/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alexander Tziamalis 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 deeper causes of inflation will make it very difficult to bring price rises down to more manageable levels.Alexander Tziamalis, Senior Lecturer in Economics, Sheffield Hallam UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1916532022-09-30T16:24:51Z2022-09-30T16:24:51ZBank of England bonds rescue has two ugly implications: more inflation and an even weaker pound<p>With UK government bonds and sterling both falling hard in recent days, the Bank of England has been forced to step in. Only a few months after it started tightening monetary policy to fight inflation by raising benchmark interest rates and ending its programme to “create” money through quantitative easing (QE), it has made a U-turn. </p>
<p>It plans to create perhaps £65 billion over a two-week period to buy long-dated government bonds to shore up that market, as well as temporarily putting on hold plans to start unwinding its £838 billion of QE money. So will this work?</p>
<p>The <a href="https://www.telegraph.co.uk/business/2022/09/28/how-chaos-pension-funds-forced-bailey-step/">specific reason</a> for the intervention appears to be UK pension funds, which suddenly became very vulnerable because of the bonds plunge. This was because pension funds rely on financial schemes known as liability-driven investment strategies or LDIs. </p>
<p>LDIs are essentially an insurance policy to ensure that funds have enough money to pay people’s pensions, even when bonds are paying very low returns. But when bond prices plunged after the government’s mini-budget, funds were forced to find extra money to cover their LDIs. This forced them to sell more bonds and threatened a domino effect where bond prices would keep falling and some funds could have collapsed. </p>
<p>The bank’s intervention has important implications for the wider economy. It comes when people are under increased financial stress because of higher interest rates, climbing energy bills, wages not keeping up with inflation and volatility in the financial markets. </p>
<p>The <a href="https://www.theguardian.com/business/2022/sep/30/uk-is-only-g7-country-with-smaller-economy-than-before-covid-19">economy is growing</a> only weakly and may well tip into recession. According to my recent <a href="https://doi.org/10.1080/1351847X.2022.2083978">co-authored work</a>, a recession could depress the UK economy for as many as 20 months – longer than the <a href="https://www.ftadviser.com/investments/2022/08/04/bank-of-england-predicts-15-month-recession/">15 months predicted</a> by the Bank of England. </p>
<p><strong>Stress in the UK markets</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/487522/original/file-20220930-24-rpdge0.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart measuring UK financial stress" src="https://images.theconversation.com/files/487522/original/file-20220930-24-rpdge0.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/487522/original/file-20220930-24-rpdge0.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=283&fit=crop&dpr=1 600w, https://images.theconversation.com/files/487522/original/file-20220930-24-rpdge0.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=283&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/487522/original/file-20220930-24-rpdge0.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=283&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/487522/original/file-20220930-24-rpdge0.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=356&fit=crop&dpr=1 754w, https://images.theconversation.com/files/487522/original/file-20220930-24-rpdge0.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=356&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/487522/original/file-20220930-24-rpdge0.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=356&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">This chart measures the volatility in the shares, bond and currency markets.</span>
<span class="attribution"><a class="source" href="https://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=290.CISS.D.GB.Z0Z.4F.EC.SS_CIN.IDX">ECB</a></span>
</figcaption>
</figure>
<p>These conditions are likely to be an additional reason for the bank’s intervention – despite contradicting its efforts at tightening. Since the interest rates (or yields) on bonds rise as their prices fall, stepping into the market to buy bonds aims to push down these rates. </p>
<p>So far it has worked: yields on UK 20-year and 30-year bonds were both north of 5% before the intervention and are now respectively 4.1% and 3.9%. Since the level of these yields sets the tone for borrowing costs in the rest of the economy, this should encourage more consumer spending and business investment. </p>
<p><strong>Yields on 20-year and 30-year UK bonds</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/487509/original/file-20220930-14-vmcmbv.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart showing yields on long-dated uk gilts" src="https://images.theconversation.com/files/487509/original/file-20220930-14-vmcmbv.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/487509/original/file-20220930-14-vmcmbv.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=337&fit=crop&dpr=1 600w, https://images.theconversation.com/files/487509/original/file-20220930-14-vmcmbv.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=337&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/487509/original/file-20220930-14-vmcmbv.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=337&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/487509/original/file-20220930-14-vmcmbv.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=424&fit=crop&dpr=1 754w, https://images.theconversation.com/files/487509/original/file-20220930-14-vmcmbv.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=424&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/487509/original/file-20220930-14-vmcmbv.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=424&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Yellow = 30-year and blue = 20-year.</span>
<span class="attribution"><a class="source" href="https://www.tradingview.com">TradingView</a></span>
</figcaption>
</figure>
<h2>The downsides</h2>
<p>The bank’s intervention, without even consulting its Monetary Policy Committee (MPC), is a form of what is known as yield curve control. This is a variety of QE in which, instead of just creating a certain amount of money with which to buy bonds, the central bank wants to achieve a specific yield. Such a policy is <a href="https://www.sipa.columbia.edu/academics/capstone-projects/bank-japan-japan-yield-curve-control-regime#:%7E:text=In%20September%202016%2C%20the%20BOJ,inflation%20overshooting%20target%20of%202%25.">mainly associated with Japan</a>, where the central bank has been buying bonds to keep yields at very low levels since 2016. </p>
<p>So far the Bank of Japan has achieved its objective, but the yen has lost a lot of value because the bank is having to create more and more money via QE: it now owns <a href="https://www.japantimes.co.jp/news/2022/07/04/business/financial-markets/boj-owns-half-jgbs/">some US$3.8 trillion</a> (£3.4 trillion) of Japanese government bonds, over half the total market. Meanwhile, the yen has virtually halved since 2010, and in recent weeks the <a href="https://www.ft.com/content/3e039392-a302-440d-9ad6-47ddecd44567">Bank of Japan had to</a> act to prop it up. </p>
<p>While Japan and the UK’s moves to control bond yields are somewhat different, the Bank of England intervention is also likely to put <a href="https://www.bankofengland.co.uk/quarterly-bulletin/2022/2022-q1/qe-at-the-bank-of-england-a-perspective-on-its-functioning-and-effectiveness">additional downward pressure</a> on sterling. It is also going to be inflationary. This shows how unappealing the policy options are at present. </p>
<h2>The implications</h2>
<p>Will the intervention work? The impact of QE on interest rates is the subject of voluminous research. It is difficult to estimate because it depends on the level of the interest rate, as well as the economic conditions. Things are <a href="https://doi.org/10.1016/j.jmoneco.2021.04.001">complicated further</a> because central bank studies find QE to be more effective than academic papers do. </p>
<p>But going roughly by the findings in this <a href="https://academic.oup.com/oxrep/article-abstract/28/4/750/343730">co-authored paper</a> of mine, an additional £50 billion of QE purchases in the UK might lower bond yields by 12 basis points (0.12 percentage points). That suggests that unless the bank continues with this new scheme far beyond the current October 14 end date, it is unlikely to have much effect. </p>
<p>Moreover, QE partly works by signalling to the markets that it will keep interest rates low for a protracted period. By setting a time limit and also saying that it plans to return to QT in due course, the bank is undermining its new policy. </p>
<p>Also, the <a href="https://www.bbc.co.uk/news/business-36629099">credit ratings agencies</a> may well downgrade UK sovereign debt. They <a href="https://doi.org/10.1016/j.jimonfin.2017.08.007">usually reduce</a> a country’s credit score when economic policy uncertainty rises significantly, or debt rises to unsustainable levels, or the quality of governance is on the slide. </p>
<p>We’re certainly seeing a big rise in uncertainty. At the same time, the <a href="https://info.worldbank.org/governance/wgi/">latest World Bank data</a> reveals that in terms of government effectiveness, the UK is down from the top 7% of countries to the top 13% over five years. What remains to be seen is how UK debt will rise, since <a href="https://www.ft.com/content/f443cfab-1d17-4d18-b274-01042270abb8">we currently</a> don’t have official forecasts following the mini-budget. </p>
<p>With no such estimates due to be published until November 23, not to mention the Bank of England’s failure to consult the MPC, the credit ratings agencies will be seriously tempted to downgrade. Such a move would push UK bond yields upwards again, therefore undermining the bank’s intervention. </p>
<p>It’s worth bearing in mind that the main source of the current instability remains the government’s mini-budget and unfunded tax cuts. This is what undermined investor confidence and caused the sell-offs of UK bonds and sterling in the first place, so the best way to reverse this is to tackle the problem at source by the government modifying its plans. </p>
<p>Having said that, such a U-turn would also leave investors very uneasy about economic management. One way or the other, a rocky economic road looks likely until at least the next general election.</p><img src="https://counter.theconversation.com/content/191653/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Costas Milas has received in the past funding by the Bank of England to work, as the principal investigator, on the project “Liquidity and output growth in the UK”. Costas Milas has received in the past ESRC funding as the principal organiser of an ESRC Seminar Series on Nonlinearities in Economics and Finance.</span></em></p>And don’t be surprised if a sovereign downgrade makes the problem even worse.Costas Milas, Professor of Finance, University of LiverpoolLicensed as Creative Commons – attribution, no derivatives.tag: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>
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<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>
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</em>
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<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>
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<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/1890762022-08-19T14:52:48Z2022-08-19T14:52:48ZInflation: why it’s very unlikely to get back below 2% for years to come<figure><img src="https://images.theconversation.com/files/480113/original/file-20220819-3561-aayy38.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Only going up. </span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/red-balloons-on-sky-111102284">Oleg Golovnev</a></span></figcaption></figure><p>Inflation in the UK and eurozone is still getting worse. <a href="https://www.telegraph.co.uk/business/2022/08/17/bank-england-expected-double-interest-rates-inflation-soars/">UK prices</a> rose a whopping 10.1% in July compared to a year earlier, while those <a href="https://www.reuters.com/markets/rates-bonds/euro-zone-july-inflation-confirmed-89-yy-core-measure-sharply-up-2022-08-18/">in the eurozone</a> went up 8.9% – breaking longstanding records in both places. Contrast this with the equivalent data from the US a few days earlier, where the 8.5% rate was lower than the previous month and below market expectations. </p>
<p>While <a href="https://www.kiplinger.com/personal-finance/inflation/605064/has-inflation-peaked-heres-what-the-experts-are-saying">some analysts believe</a> that <a href="https://www.aljazeera.com/economy/2022/8/10/is-global-inflation-nearing-a-peak">US prices</a> have now peaked, most think that the UK and eurozone, which are <a href="https://theconversation.com/why-are-gas-prices-still-high-despite-oil-getting-cheaper-and-what-will-happen-next-energy-expert-qanda-188767">much more exposed</a> to the effects of the Ukraine war, have a way to go yet. Even the Bank of England <a href="https://www.bankofengland.co.uk/-/media/boe/files/monetary-policy-report/2022/august/monetary-policy-report-august-2022.pdf">is saying that</a> UK inflation will peak at over 13% later in 2022, before gradually returning to the 2% target level within two years. </p>
<p><strong>UK inflation vs US and Europe</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/480056/original/file-20220819-1459-gtzzkg.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph comparing UK, US and eurozone inflation" src="https://images.theconversation.com/files/480056/original/file-20220819-1459-gtzzkg.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/480056/original/file-20220819-1459-gtzzkg.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=296&fit=crop&dpr=1 600w, https://images.theconversation.com/files/480056/original/file-20220819-1459-gtzzkg.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=296&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/480056/original/file-20220819-1459-gtzzkg.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=296&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/480056/original/file-20220819-1459-gtzzkg.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=372&fit=crop&dpr=1 754w, https://images.theconversation.com/files/480056/original/file-20220819-1459-gtzzkg.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=372&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/480056/original/file-20220819-1459-gtzzkg.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"></span>
<span class="attribution"><span class="source">Trading Economics</span></span>
</figcaption>
</figure>
<p>The prospect of more inflation is very bad news, since it reduces people’s real incomes and might also reduce investment, trade and economic growth. On top of that, the “cure” of raising interest rates can be harmful in its own right by making borrowing less attractive and driving down the value of everything from houses to shares. </p>
<p>But we also think it’s too optimistic to expect inflation to drop to 2% any time soon. More likely, we have entered a phase where various structural factors will keep it elevated for years to come. </p>
<h2>Transitory inflation?</h2>
<p>Until recently, central banks and the majority of economists and commentators <a href="https://www.ft.com/content/144460b0-887a-408f-89b6-e629cadd617f">attributed rising prices</a> to temporary factors and claimed this would stop without much intervention. They mainly blamed logistic bottlenecks and production constraints due to the COVID-19 lockdowns. They also argued that as the cost of many products had been abnormally subdued during the lockdowns, it was inevitable that inflation would temporarily spike when prices returned to previous levels. </p>
<p>When prices started rising more widely and violently – which <a href="https://theconversation.com/rising-inflation-unless-we-act-now-it-will-not-be-temporary-168106">we predicted</a> in a previous article a year ago – central banks and many economists <a href="https://obr.uk/box/how-does-the-russian-invasion-of-ukraine-affect-the-uk-economy/">started blaming</a> the war in Ukraine and the elevated energy and food prices that came with it. But while all these factors have helped to drive inflation, they are not the whole story. </p>
<p><strong>UK inflation 1997-2022</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/480057/original/file-20220819-1373-67fm5m.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph showing UK inflation since 1997" src="https://images.theconversation.com/files/480057/original/file-20220819-1373-67fm5m.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/480057/original/file-20220819-1373-67fm5m.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=262&fit=crop&dpr=1 600w, https://images.theconversation.com/files/480057/original/file-20220819-1373-67fm5m.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=262&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/480057/original/file-20220819-1373-67fm5m.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=262&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/480057/original/file-20220819-1373-67fm5m.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=329&fit=crop&dpr=1 754w, https://images.theconversation.com/files/480057/original/file-20220819-1373-67fm5m.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=329&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/480057/original/file-20220819-1373-67fm5m.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=329&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</a></span>
</figcaption>
</figure>
<p>There is one clear cause of inflation that central bankers are not eager to advertise, namely the record low interest rates and expansion of the money supply through quantitative easing that they have been implementing since the 2008 financial crisis. In centuries of capitalism, we’ve never seen such low interest rates before.</p>
<p><strong>UK benchmark interest rate 1997-2022</strong> </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/480072/original/file-20220819-2895-67fm5m.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph showing UK base rate since 1997" src="https://images.theconversation.com/files/480072/original/file-20220819-2895-67fm5m.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/480072/original/file-20220819-2895-67fm5m.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=255&fit=crop&dpr=1 600w, https://images.theconversation.com/files/480072/original/file-20220819-2895-67fm5m.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=255&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/480072/original/file-20220819-2895-67fm5m.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=255&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/480072/original/file-20220819-2895-67fm5m.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=321&fit=crop&dpr=1 754w, https://images.theconversation.com/files/480072/original/file-20220819-2895-67fm5m.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=321&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/480072/original/file-20220819-2895-67fm5m.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=321&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/interest-rate">Trading Economics/Bank of England</a></span>
</figcaption>
</figure>
<p>This ultra-loose monetary policy has created a backdrop of high demand at a time when production capabilities and the supply of cheap energy and imports have been disrupted. It has also pushed all asset classes – property, shares, precious metals, cryptocurrencies and so on – into bubble territory. </p>
<p>This has created <a href="https://positivemoney.org/2018/04/bank-england-working-paper-considers-monetary-policys-effect-inequality/">record levels</a> of inequality across our societies, while also further inflating demand by making people who hold these assets feel <a href="https://www.investopedia.com/terms/w/wealtheffect.asp">they can afford</a> to spend more. Households as well as businesses have taken on cheap debt to finance properties and investments, or just to stay afloat. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/tinkering-with-the-mortgage-market-wont-solve-the-uk-housing-affordability-crisis-186146">Tinkering with the mortgage market won't solve the UK housing affordability crisis</a>
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</em>
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<hr>
<p>Thanks to these high debt levels and high asset prices, central banks will need to tread very carefully when it comes to raising interest rates to combat inflation. Yet if they only hike interest rates a little, inflation will stay higher for longer. </p>
<h2>Currencies, Brexit and globalisation</h2>
<p>As far as the UK is concerned, the pound sterling is another factor likely to stoke inflation for years to come. It has already been weakening in comparison to other international currencies for a number of years, causing imports such as food, energy, cars and clothes to become more expensive. </p>
<p>There are numerous reasons to assume that this trend continues. <a href="https://www.weforum.org/agenda/2022/06/rates-inflation-federal-reserve-united-states/">Very aggressive</a> interest rate rises in the US are making the <a href="https://www.bloomberg.com/news/articles/2022-06-22/uk-should-worry-about-sterling-s-10-decline-senior-mp-says">dollar more appealing</a>, which lowers the value of other international currencies. The chronic under-investment and consequent <a href="https://theconversation.com/inflation-theres-a-vital-way-to-reduce-it-that-everyone-overlooks-raise-productivity-183938">productivity gap</a> in the UK compared to other G7 countries is another issue. </p>
<p>The pound also faces growing separatist sentiment in Northern Ireland and a looming second independence referendum in Scotland. Then there is Brexit. It is <a href="https://obr.uk/box/the-latest-evidence-on-the-impact-of-brexit-on-uk-trade/">weakening trade</a> with the EU and <a href="https://www.investmentmonitor.ai/analysis/two-years-brexit-uk-eu">reducing business investment</a>, <a href="https://economy2030.resolutionfoundation.org/wp-content/uploads/2022/06/The_Big-Brexit.pdf">both of which</a> weigh on the currency. </p>
<p>There is also the looming prospect of a trade war with the EU. And incidentally, the loss of hundreds of thousands of EU professionals from the UK workforce is aggravating the nation’s <a href="https://www.ft.com/content/96e43c16-f592-11e9-bbe1-4db3476c5ff0">longstanding skills gap</a>. This is helping to make <a href="https://www.theweek.co.uk/business/economy/956951/labour-shortages-urgent-problem-economy">wages more expensive</a> and <a href="https://www.resolutionfoundation.org/press-releases/brexit-has-damaged-britains-competitiveness-and-will-make-us-poorer-in-the-decade-ahead/">reducing production</a>, which will also lead to higher prices. </p>
<p>It should be said that the eurozone is also suffering from a weak currency. Alongside the Federal Reserve’s interest rate policy in the US, the EU also has to bear the brunt of the Russian gas crisis and structural economic problems in countries such as Italy and Spain that have never been resolved. Although the pound’s weakness is worse overall, the euro is nudging US dollar parity for the first time in two decades. </p>
<p><strong>Pound and euro values 2008-2022</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/480082/original/file-20220819-20-gtzzkg.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph showing the value of the pound and euro since 2008" src="https://images.theconversation.com/files/480082/original/file-20220819-20-gtzzkg.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/480082/original/file-20220819-20-gtzzkg.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=337&fit=crop&dpr=1 600w, https://images.theconversation.com/files/480082/original/file-20220819-20-gtzzkg.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=337&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/480082/original/file-20220819-20-gtzzkg.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=337&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/480082/original/file-20220819-20-gtzzkg.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=424&fit=crop&dpr=1 754w, https://images.theconversation.com/files/480082/original/file-20220819-20-gtzzkg.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=424&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/480082/original/file-20220819-20-gtzzkg.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=424&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">This chart shows the value of the euro and pound against a basket of international currencies. The pound is in orange and the euro in blue.</span>
<span class="attribution"><a class="source" href="https://www.tradingview.com">TradingView</a></span>
</figcaption>
</figure>
<p>Across the world, a final critical factor is the <a href="https://theconversation.com/china-us-tensions-how-global-trade-began-splitting-into-two-blocs-188380">partial reversal of globalisation</a>. <a href="https://www.ft.com/content/e17f3abf-b0c0-4855-8b0f-8d0fa5a26872">According to</a> Agustín Carstens, the head of the Bank for International Settlements (often described as the central bank of the central banks), <a href="https://www.ft.com/content/e17f3abf-b0c0-4855-8b0f-8d0fa5a26872">this will</a> increase product prices and keep inflation higher than it would have been for years to come. </p>
<p>There will be other factors that will counteract inflation. One is the retiral of the baby boomers, the largest generation ever seen, who will consume less as they stop working. Another is that technological advances continually increase productivity, which makes it cheaper to produce each unit. But with so many pressures driving prices up in the coming years, the overall likelihood is that inflation will remain stubbornly above central banks’ mandates of about 2%. This will have repercussions for consumption, profits, insolvencies and the stock market – not to mention economic growth overall.</p><img src="https://counter.theconversation.com/content/189076/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>Many central bankers and economists are forecasting a return to low inflation within a couple of years, but that’s wishful thinking.Alexander Tziamalis, Senior Lecturer in Economics, Sheffield Hallam UniversityYuan Wang, Seinor Lecturer in Economics, Sheffield Hallam UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1802082022-03-29T15:28:21Z2022-03-29T15:28:21ZWhat is an inverting yield curve and does it mean we’re heading for a recession?<figure><img src="https://images.theconversation.com/files/455032/original/file-20220329-4070-1vdhhgl.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Not looking healthy. </span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-illustration/3d-illustration-inverted-yield-curve-over-1892649385">hafakot</a></span></figcaption></figure><p>One key predictor of downturns in the economy is what is known as the yield curve. This typically refers to the market for what the US government borrows, by issuing bonds and other securities that mature over different time horizons ranging from weeks to 30 years. </p>
<p>Each of these securities has its own yield (or interest rate), which moves up and down in inverse proportion to the security’s market value – so when bonds are trading at high prices, their yields will be low and vice versa. You can draw a chart that plots the yields of securities at each maturity date to see how they relate to one another, and this is known as the yield curve. </p>
<p>In normal times, as a compensation for higher risk, investors expect expect higher rates of interest for money they lend over a longer time horizon. To reflect this, the yield curve normally slopes up. When it instead slopes down – in other words, when it inverts – it is a sign that investors are more pessimistic about the long term than short term: they think a downturn or a recession is coming soon. </p>
<p>This is because they expect the Federal Reserve, the US central bank, is going to cut short-term interest rates in future to stimulate a struggling economy (as opposed to raising rates to cool down an economy that is overheating). </p>
<p>Most closely watched is the relationship between two-year and ten-year US treasury debt. The so-called spread between these two metrics can be seen in the chart below, with the grey areas indicating recessions that have tended to follow shortly after. </p>
<p><strong>Spread between two-year and ten-year treasuries</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/454797/original/file-20220328-23-1imwb3k.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Spreads between 2-year and 10-year bonds" src="https://images.theconversation.com/files/454797/original/file-20220328-23-1imwb3k.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/454797/original/file-20220328-23-1imwb3k.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=163&fit=crop&dpr=1 600w, https://images.theconversation.com/files/454797/original/file-20220328-23-1imwb3k.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=163&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/454797/original/file-20220328-23-1imwb3k.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=163&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/454797/original/file-20220328-23-1imwb3k.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=204&fit=crop&dpr=1 754w, https://images.theconversation.com/files/454797/original/file-20220328-23-1imwb3k.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=204&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/454797/original/file-20220328-23-1imwb3k.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=204&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://fred.stlouisfed.org/series/T10Y2Y">St Louis Fed</a></span>
</figcaption>
</figure>
<p>As you can see, the yields of these two securities are getting very close to being the same, and the trend suggests that the two-year will soon have a higher yield – meaning the curve is inverting. The key question is, does an inverted yield curve hint at an upcoming downturn? Not necessarily. Let me explain why. </p>
<h2>Inflation expectations</h2>
<p>One complication is that bond yields don’t only reflect what investors think about future economic growth. They also buy or sell debt securities depending on what they think is going to happen to inflation. It’s generally assumed that prices will increasingly rise in the years ahead, and investors need to be compensated for bearing that risk, since higher inflation will erode their future purchasing power. For this reason, bond yields contain an element of inflation premium, normally with an increasingly higher premium for bonds with longer maturity dates. </p>
<p>The following chart shows the spread between the inflation expectations built into 10-year and 2-year treasuries. The fact that it is in negative territory suggests the market thinks that inflation may fall, and this may also explain why yields on longer-dated treasuries are lower than on shorter-dated ones. And although inflation would fall in the event of an economic slowdown or recession, there could be a situation where inflation fell but the economy remained buoyant. Hence a yield curve inversion doesn’t have to mean that we are up against an imminent recession. </p>
<p><strong>Inflation expectations (ten-year vs two-year treasuries)</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/454939/original/file-20220329-26-y1t9rq.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart of the spread between inflation expectations in 10-yr and 2-yr treasuries" src="https://images.theconversation.com/files/454939/original/file-20220329-26-y1t9rq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/454939/original/file-20220329-26-y1t9rq.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=216&fit=crop&dpr=1 600w, https://images.theconversation.com/files/454939/original/file-20220329-26-y1t9rq.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=216&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/454939/original/file-20220329-26-y1t9rq.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=216&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/454939/original/file-20220329-26-y1t9rq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=272&fit=crop&dpr=1 754w, https://images.theconversation.com/files/454939/original/file-20220329-26-y1t9rq.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=272&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/454939/original/file-20220329-26-y1t9rq.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=272&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://fred.stlouisfed.org/series/T10Y2Y">St Louis Fed</a></span>
</figcaption>
</figure>
<h2>Quantitative easing</h2>
<p>Another factor that is potentially affecting the yield curve is the Federal Reserve’s moves to buy government debt as part of its <a href="https://www.investopedia.com/terms/q/quantitative-easing.asp">quantitative easing programme</a> (QE). The idea behind QE is that by buying long-term bonds, the Fed is able to keep long-term interest rates low, which decreases the rates on mortgages and other loans, thereby stimulating the economy. Conversely, when sold, lending rates will go up and economic activity will be reduced. </p>
<p>Earlier in March, the Fed started raising the benchmark US interest rate and stopped the asset purchases under the QE programme that it launched in 2020 in response to the COVID pandemic. But it also indicated that it would only start selling these assets after several months of hiking the benchmark rate. Since the benchmark rate is a short-term rate, the yield curve inverting might indicate market expectations that short-term interest rates will be higher than long-term ones for the foreseeable future. </p>
<h2>Which yield curve should we consider?</h2>
<p>It is also sometimes argued that two-year/ten-year spreads are not the most useful ones to watch, and that instead <a href="https://www.cnbc.com/video/2022/03/25/what-the-inverted-yield-curve-means-for-short-term-economic-outlook.html?&qsearchterm=yield%20curve">one should focus</a> on yields at the shorter end of the yield curve. In this set up, if you look at the difference in yields between two-year and three-month treasuries, it is <a href="https://www.cnbc.com/2022/03/17/kelly-evans-the-yield-curve-is-actually-steepening.html?&qsearchterm=yield%20curve">actually steepening</a>: in other words, it is hinting that economic growth is going to increase in the short term. </p>
<p>Economists sometimes argue that these near-term yield curve movements have stronger predictive power than those further out. At the very least, the fact that these are saying something different shows the need to be careful because different data about treasury yields can depict a different (or even opposite) picture depending on what time horizon you are considering. </p>
<p><strong>Spread between two-year and three-month treasury yields</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/454944/original/file-20220329-26-s2b3cq.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart comparing 2-year and 3-month treasury yields over time" src="https://images.theconversation.com/files/454944/original/file-20220329-26-s2b3cq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/454944/original/file-20220329-26-s2b3cq.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=226&fit=crop&dpr=1 600w, https://images.theconversation.com/files/454944/original/file-20220329-26-s2b3cq.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=226&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/454944/original/file-20220329-26-s2b3cq.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=226&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/454944/original/file-20220329-26-s2b3cq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=284&fit=crop&dpr=1 754w, https://images.theconversation.com/files/454944/original/file-20220329-26-s2b3cq.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=284&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/454944/original/file-20220329-26-s2b3cq.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=284&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://fred.stlouisfed.org/series/T10Y2Y">St Louis Fed</a></span>
</figcaption>
</figure>
<p>To summarise, it doesn’t necessarily follow that an inverted yield curve will be followed by a recession. It certainly could mean that, in which case unemployment would likely rise and inflation would potentially come down more quickly than many are expecting. But for now, it’s too early to say. The debt market is certainly signalling that change is coming, though it’s often easier to say in hindsight what it meant than at the present time.</p><img src="https://counter.theconversation.com/content/180208/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Luciano Rispoli 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>Normally investors view the future as more uncertain than the present. When that turns on its head, it’s often a bad omen.Luciano Rispoli, Teaching Fellow in Economics, University of SurreyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1775062022-02-21T15:24:12Z2022-02-21T15:24:12ZStock markets have been a one-way bet for many years thanks to the ‘Fed put’ – but those days are over<p>The prospect of a Russian invasion of Ukraine have sent the markets into a tailspin, compounding fears around inflation that have been building over the past few months. The S&P 500 is trading at 10% below its recent all-time high, while the Nasdaq is down by over 16%. </p>
<hr>
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<p><em>You can listen to more articles from The Conversation, narrated by Noa, <a href="https://theconversation.com/uk/topics/audio-narrated-99682">here</a>.</em></p>
<hr>
<p>The markets have been inflated for years by very easy monetary conditions in which interest rates have been ultra-low and central banks have been “printing money” in the form of <a href="https://www.bankofengland.co.uk/monetary-policy/quantitative-easing">quantitative easing</a> (QE). But one additional factor that has encouraged investors to put so much money into the markets is the so-called “<a href="https://faculty.haas.berkeley.edu/vissing/cieslak_vissingjorgensen.pdf">Fed put</a>”. This is the idea that the US Federal Reserve (and other central banks) will not allow the markets to fall beyond a certain threshold – say 20% to 25% – before riding to the rescue with lower rates and more QE. </p>
<p>Such is the debt in the global financial system, goes the logic, that the markets cannot be allowed to fall any further. A bigger drop could set off a chain reaction of bad debts that could destabilise the biggest banks and cause a crisis that would make 2008 look mild. </p>
<p>Known as <a href="https://www.investopedia.com/options-basics-tutorial-4583012#:%7E:text=Call%20and%20Put%20Options,-Options%20are%20a&text=If%20you%20buy%20an%20options,right%20to%20sell%20a%20stock.">a “put”</a> in reference to a financial instrument that options traders buy to protect themselves from a fall in the markets, the argument is that markets are effectively a one-way bet. Certainly, the S&P 500 has risen sixfold since 2009 and the Nasdaq 12-fold as central banks have eased monetary conditions repeatedly. Even the under-performing FTSE 100 is up by two-thirds over the same period. </p>
<p>We would argue, however, that the Fed put no longer exists. Let us explain why. </p>
<h2>The put in action</h2>
<p>The idea emerged when <a href="https://www.federalreservehistory.org/people/alan-greenspan">Alan Greenspan</a> was chair of the Federal Reserve. Starting with the Black Monday crash of autumn 1987, Greenspan became known for cutting the federal funds interest rate to improve investor sentiment when markets dropped significantly. This was a big shift from the Fed’s previously very slow and cautious approach to changes in the business environment. </p>
<p>When Greenspan cut aggressively after the dotcom crash in the early 2000s, it helped to inflate the US subprime housing bubble that precipitated the 2007-09 crisis. During that crisis, the <a href="https://www.federalreserve.gov/newsevents/speech/bernanke20090113a.htm">Fed’s response</a> – now under Ben Bernanke – was again to cut rates and also to increase the money supply through QE. This extra money encouraged financial institutions to lend to businesses and consumers to haul the wider economy out of recession, and <a href="https://www.brookings.edu/wp-content/uploads/2016/06/11_origins_crisis_baily_litan.pdf">lend more</a> to traders so that they could plough it into the markets. </p>
<p><strong>Federal Funds rate 1972 to present</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/447501/original/file-20220221-14-ywm2k0.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Federal Funds rate over time" src="https://images.theconversation.com/files/447501/original/file-20220221-14-ywm2k0.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/447501/original/file-20220221-14-ywm2k0.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=260&fit=crop&dpr=1 600w, https://images.theconversation.com/files/447501/original/file-20220221-14-ywm2k0.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=260&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/447501/original/file-20220221-14-ywm2k0.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=260&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/447501/original/file-20220221-14-ywm2k0.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=327&fit=crop&dpr=1 754w, https://images.theconversation.com/files/447501/original/file-20220221-14-ywm2k0.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=327&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/447501/original/file-20220221-14-ywm2k0.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=327&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-states/interest-rate">Trading Economics</a></span>
</figcaption>
</figure>
<p>The effect of this QE was to expand the <a href="https://www.bankrate.com/banking/federal-reserve/federal-reserve-balance-sheet/">Fed’s balance sheet</a> (in other words, its assets and liabilities) after years of being flat at around US$1 trillion (£733 trillion) to a peak of <a href="https://www.brookings.edu/blog/up-front/2019/05/17/the-feds-bigger-balance-sheet-in-an-era-of-ample-reserves/">US$4.5 trillion</a> in 2014. The Fed then <a href="https://www.ecb.europa.eu/pub/conferences/ecbforum/shared/pdf/2014/ferguson_paper.pdf">very slowly</a> began unwinding these holdings and raising the Fed funds rate from 0.25% to 2.5%, but after a sharp 20% fall in the S&P 500 in late 2018 (and also a drop in government bond prices), it started cutting rates again. </p>
<p>The Fed did continue unwinding QE in the first half of 2019, getting its balance sheet below US$4 trillion. But it went into reverse later in the year after a spike in the crucial <a href="https://ig.ft.com/repo-rate/">“repo” rate</a> at which banks lend funds to one another overnight, which prompted concerns about the prospect of another 2008-style panic. </p>
<p>In March 2020 as the global economy shut down in the face of the <a href="https://www.nytimes.com/2021/02/26/opinion/sunday/coronavirus-alive-dead.html">COVID pandemic</a>, the Fed then swung into full rescue mode. It announced the most aggressive QE programme to date to support the economy, and the balance sheet ballooned to nearly <a href="https://www.ft.com/content/9af75cb4-9743-41af-896f-f25d7588d323">US$9 trillion</a> by late 2021. </p>
<p><strong>Federal Reserve balance sheet</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/447500/original/file-20220221-26-24vjj6.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Fed balance sheet over time" src="https://images.theconversation.com/files/447500/original/file-20220221-26-24vjj6.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/447500/original/file-20220221-26-24vjj6.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=363&fit=crop&dpr=1 600w, https://images.theconversation.com/files/447500/original/file-20220221-26-24vjj6.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=363&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/447500/original/file-20220221-26-24vjj6.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=363&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/447500/original/file-20220221-26-24vjj6.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=456&fit=crop&dpr=1 754w, https://images.theconversation.com/files/447500/original/file-20220221-26-24vjj6.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=456&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/447500/original/file-20220221-26-24vjj6.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=456&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.statista.com/statistics/1121448/fed-balance-sheet-timeline/">Statista</a></span>
</figcaption>
</figure>
<p><a href="https://www.gla.ac.uk/media/Media_219105_smxx.pdf">The result</a> of all this easing has been a huge surge in asset prices – not only stocks and bonds but also property. Though <a href="https://www.marketplace.org/2021/03/03/did-the-federal-reserve-make-economic-inequality-worse/">it’s difficult</a> to estimate the effect, the wealthiest 10% in the US now own over 60% of assets, while the poorest 50% own less than 6%. </p>
<h2>The situation now</h2>
<p>The recent falls in stock markets (and bond markets) are taking place while the US economy is performing well. It grew by nearly <a href="https://www.ft.com/content/d44294d5-879d-4013-a79e-82f117b805c5">6% in 2021</a> despite the pandemic. The labour market is robust and <a href="https://www.vox.com/2019/3/18/18270916/labor-shortage-workers-us">lower-skilled workers</a> are finding new opportunities with higher wages. </p>
<p>Yet <a href="https://www.conference-board.org/topics/consumer-confidence">consumer confidence</a> is low, which is partly <a href="https://www.bls.gov/cpi/">due to inflation</a>. Consumer prices in the US rose by a <a href="https://www.bls.gov/opub/ted/2022/consumer-prices-up-7-5-percent-over-year-ended-january-2022.htm">staggering 7.5%</a> over the 12 months to January 2022, the largest since the early 1980s, while the situation has been <a href="https://www.theguardian.com/business/2022/feb/16/uk-inflation-rises-amid-cost-of-living-crisis">similar elsewhere</a>, including in the UK. </p>
<p>The big fear is that workers begin demanding equivalent pay rises in response. This could cause a <a href="https://www.economist.com/leaders/workers-have-the-most-to-lose-from-a-wage-price-spiral/21807722">wage-price spiral</a> in which producers further raise their prices to pay for higher wages, sparking further wage demands and so on – essentially making inflation a <a href="https://theconversation.com/inflation-why-it-is-the-biggest-test-yet-for-central-bank-independence-173676">longer-term problem</a>. </p>
<p>The Fed is tightening monetary conditions to try and get inflation under control: paring back QE to end in March with a view to beginning to reduce the balance sheet later in the year, and signalling that <a href="https://www.forbes.com/sites/jonathanponciano/2022/02/16/stocks-keep-struggling-after-fed-minutes-signal-march-interest-rate-hike-still-on-track/">the federal funds rate</a> will start going up from its current 0.25% in March. </p>
<p>When central banks tighten in this way, it tends to cause economic slowdowns <a href="https://www.wsj.com/articles/behind-the-feds-slow-pivot-to-tackling-inflation-11644930180">and recessions</a>. Together with the prospect of less QE money available for traders, this helps to explain why the markets have been going down. The question is what happens if the markets fall much further: will the Fed and other central banks keep tightening or go into reverse? </p>
<p>There’s a big variation <a href="https://www.bloomberg.com/news/articles/2022-01-29/goldman-sachs-predicts-fed-will-raise-rates-five-times-this-year">in expectations</a> about interest rates, which indicates that nobody is sure. In our view, the Fed and other central banks are likely to tighten fairly aggressively – in line with what the current Fed chair, Jay Powell, <a href="https://www.ft.com/content/c556a131-951d-4283-9e10-36becf77579f">has been signalling</a>. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/447541/original/file-20220221-16-srsh64.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Lots of cartoon men and a compass with financial crisis on it" src="https://images.theconversation.com/files/447541/original/file-20220221-16-srsh64.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/447541/original/file-20220221-16-srsh64.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=420&fit=crop&dpr=1 600w, https://images.theconversation.com/files/447541/original/file-20220221-16-srsh64.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=420&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/447541/original/file-20220221-16-srsh64.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=420&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/447541/original/file-20220221-16-srsh64.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=528&fit=crop&dpr=1 754w, https://images.theconversation.com/files/447541/original/file-20220221-16-srsh64.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=528&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/447541/original/file-20220221-16-srsh64.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=528&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Investors should not be resting easily.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/financial-crisis-words-on-pocket-watch-553762525">Light and Dark Studio</a></span>
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</figure>
<p>This time is likely to be different for several reasons. Inflation has never before been an issue during the era of the Fed put. It risks seriously damaging the Fed’s credibility, not to mention impoverishing ordinary people with potentially grave political consequences. </p>
<p>The financial system is also very different to in 2008. Whereas part of the problem during the global financial crisis was banks with too little capital to protect themselves, the system is <a href="https://eur01.safelinks.protection.outlook.com/?url=https%3A%2F%2Fblogs.worldbank.org%2Fallaboutfinance%2Fbank-regulation-and-supervision-decade-after-global-financial-crisis&data=04%7C01%7Ce.t.jones%40bangor.ac.uk%7C18307e2a20834d63b3ce08d9f4a28dab%7Cc6474c55a9234d2a9bd4ece37148dbb2%7C0%7C0%7C637809801262885395%7CUnknown%7CTWFpbGZsb3d8eyJWIjoiMC4wLjAwMDAiLCJQIjoiV2luMzIiLCJBTiI6Ik1haWwiLCJXVCI6Mn0%3D%7C3000&sdata=d%2BIpbAzshlV97oYRUv4ABqW%2FdUJE5J9GoNrSMG2CEjk%3D&reserved=0">better regulated now</a>. </p>
<p>At the same time, the pandemic has also been a very different economic crisis to other recent ones. Most recent crises, including 2007-09, were caused by problems within the financial system – what economists refer to as an “<a href="https://www.wider.unu.edu/publication/covid-19-really-exogenous-shock#:%7E:text=Endogenous%20shocks%20arise%20from%20within,from%20within%20the%20economic%20system.&text=A%20truly%20exogenous%20shock%20would,the%20tsunami%20in%20its%20wake.">endogenous shock</a>”. Something external such as a pandemic is an “exogenous” shock, and these tend to be quickly absorbed by healthy financial systems, with growth resuming smoothly once the disruption ends. </p>
<p>Raising rates and winding down QE should be <a href="https://eur01.safelinks.protection.outlook.com/?url=https%3A%2F%2Fwww.ft.com%2Fcontent%2F9c153d31-6f59-43f9-b7b2-8ba269b645dd&data=04%7C01%7Ce.t.jones%40bangor.ac.uk%7C18307e2a20834d63b3ce08d9f4a28dab%7Cc6474c55a9234d2a9bd4ece37148dbb2%7C0%7C0%7C637809801262885395%7CUnknown%7CTWFpbGZsb3d8eyJWIjoiMC4wLjAwMDAiLCJQIjoiV2luMzIiLCJBTiI6Ik1haWwiLCJXVCI6Mn0%3D%7C3000&sdata=Gpo5EstE5EsnZVwEKnyhBv4GbZT8nyL796728ToZIcM%3D&reserved=0">much more achievable</a> with today’s healthy, properly functioning financial system. It is therefore much less likely that the central banks will rescue the financial markets from a crash by U-turning on tightening out of fear that the system won’t cope. </p>
<p>How far markets fall as the economy slows down depends on many things, not least the <a href="https://eur01.safelinks.protection.outlook.com/?url=https%3A%2F%2Fedition.cnn.com%2F2022%2F02%2F18%2Feurope%2Fukraine-russia-conflict-explainer-cmd-intl%2Findex.html&data=04%7C01%7Ce.t.jones%40bangor.ac.uk%7C18307e2a20834d63b3ce08d9f4a28dab%7Cc6474c55a9234d2a9bd4ece37148dbb2%7C0%7C0%7C637809801262885395%7CUnknown%7CTWFpbGZsb3d8eyJWIjoiMC4wLjAwMDAiLCJQIjoiV2luMzIiLCJBTiI6Ik1haWwiLCJXVCI6Mn0%3D%7C3000&sdata=r9SHQ8zG%2FBccQRmVn7uWC%2FdEq477pY%2FTBnORkT%2FCtVk%3D&reserved=0">Ukraine-Russia conflict</a> and the path of inflation. But with the Fed put arguably no longer in play, everyone from pension holders to retail investors should tread very carefully.</p><img src="https://counter.theconversation.com/content/177506/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>A market crash may be more likely than at any time in a generation.Edward Thomas Jones, Lecturer in Economics, Bangor UniversityYener Altunbas, Professor of Banking, Bangor UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1743502022-01-04T14:39:22Z2022-01-04T14:39:22ZWorld economy in 2022: the big factors to watch closely<figure><img src="https://images.theconversation.com/files/439317/original/file-20220104-27-m98ms4.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Nothing but conundrums. </span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-illustration/global-politics-globalization-3d-concept-78306874">koya979</a></span></figcaption></figure><p>Will 2022 be the year where the world economy recovers from the pandemic? That’s the big question on everyone’s lips as the festive break comes to an end. </p>
<p>One complicating factor is that most of the latest major forecasts were published in the weeks before the <a href="https://www.who.int/news/item/26-11-2021-classification-of-omicron-(b.1.1.529)-sars-cov-2-variant-of-concern">omicron variant</a> swept the world. At that time, the mood was that recovery was indeed around the corner, with the IMF projecting <a href="https://www.imf.org/en/Publications/WEO/Issues/2021/10/12/world-economic-outlook-october-2021">4.9% growth</a> in 2022 and the OECD <a href="https://www.oecd.org/newsroom/oecd-economic-outlook-sees-recovery-continuing-but-warns-of-growing-imbalances-and-risks.htm">projecting 4.5%</a>. These numbers are lower than the circa 5% to 6% global growth expected to have been achieved in 2021, but that represents the inevitable rebound from reopening after the pandemic lows of 2020. </p>
<p>So what difference will omicron make to the state of the economy? We already know that it had an effect in the run-up to Christmas, with for example <a href="https://www.theguardian.com/business/live/2021/dec/23/omicron-hits-uk-economy-growth-car-production-market-optimism-energy-crisis-business-live?filterKeyEvents=false&page=with:block-61c46e4c8f08efd5f0de270a#block-61c46e4c8f08efd5f0de270a">UK hospitality</a> taking a hit as people stayed away from restaurants. For the coming months, the combination of raised restrictions, cautious consumers and people taking time off sick is likely to take its toll. </p>
<p>Yet the fact that the new variant seems milder than originally feared is likely to mean that restrictions are lifted more quickly and that the economic effect is more moderate than it might have been. <a href="https://www.reuters.com/world/middle-east/israel-admit-some-foreigners-with-presumed-covid-immunity-jan-9-2022-01-03/">Israel</a> and <a href="https://www.aljazeera.com/economy/2022/1/3/australia-pushes-on-with-reopening-amid-milder-impact-of-omicron">Australia</a>, for example, are already loosening restrictions despite high case numbers. At the same time, however, until the west tackles very low <a href="https://ourworldindata.org/covid-vaccinations?country=OWID_WRL">vaccination rates</a> in some parts of the world, don’t be surprised if another new variant brings further damage to both public health and the world economy. </p>
<p>As things stand, the UK thinktank the Centre for Economics and Business Research (CEBR) published a more recent <a href="https://www.bloomberg.com/news/articles/2021-12-26/world-economy-now-set-to-surpass-100-trillion-in-2022">2022 forecast</a> just before Christmas. It predicted that global growth would reach 4% this year, and that the total world economy would hit a new all-time high of US$100 trillion (£74 trillion). </p>
<h2>The inflation question</h2>
<p>One other big unknown is inflation. In 2021 we saw a sudden and sharp surge in inflation resulting from the restoration of global economic activity and bottlenecks in the <a href="https://obr.uk/box/the-economic-effects-of-supply-bottlenecks/">global supply chain</a>. There has been <a href="https://theconversation.com/inflation-why-its-temporary-and-raising-interest-rates-will-do-more-harm-than-good-172329">much debate</a> about whether this inflation will prove temporary, and central banks have been coming under pressure to ensure it doesn’t spiral. </p>
<p>So far, the European Central Bank, Federal Reserve and Bank of Japan have all abstained from raising interest rates from their very low levels. The Bank of England, on the other hand, followed the <a href="https://www.ft.com/content/ca15ce59-ca72-497c-bf7a-c1482d972f01">IMF’s advice</a> and <a href="https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2021/december-2021">raised rates</a> from 0.1% to 0.25% in December. This is too little to curb inflation or do any good besides increase the cost of borrowing for firms and to raise <a href="https://www.bbc.com/news/business-59140059">mortgage payments</a> for households. That said, the <a href="https://www.reuters.com/markets/europe/sterling-nears-2-year-high-vs-euro-rate-rise-bets-2022-01-04/">markets are betting</a> that more UK rate rises will follow, and that <a href="https://www.cnbc.com/2022/01/03/markets-and-the-economy-brace-as-the-feds-first-hike-could-come-in-two-months.html">the Fed</a> will also start raising rates in the spring. </p>
<p>Yet the more important question regarding inflation is what happens to quantitative easing (QE). This is the policy of increasing the money supply that has seen the major central banks <a href="https://www.atlanticcouncil.org/global-qe-tracker/">buying some</a> US$25 trillion in government bonds and other financial assets in recent years, including about US$9 trillion on the back of COVID. </p>
<p>Both the Fed and ECB are still operating QE and adding assets to their balance sheets every month. The Fed is <a href="https://www.businessinsider.com/personal-finance/fed-tapering?r=US&IR=T">currently tapering</a> the rate of these purchases with a view to stopping them in March, having recently announced that it would bring forward the end date from June. <a href="https://www.ft.com/content/03a30484-b265-4a88-a861-de1784305d40">The ECB</a> has also said it will scale back QE, but is committed to continuing for the time being. </p>
<p>Of course, the real question is what these central banks do in practice. Ending QE and raising interest rates will undoubtedly hamper the recovery – the <a href="https://cebr.com/reports/city-am-uk-to-remain-one-of-the-top-six-global-economies-post-covid-says-cebr-report/">CEBR forecast</a>, for example, assumes that it will see bond, stock and property markets falling by 10% to 25% in 2022. It will be interesting to see whether the prospect of such upheaval forces the Fed and Bank of England to get more dovish again – particularly when you factor in the continued uncertainty around COVID. </p>
<h2>Politics and global trade</h2>
<p>The trade war between the US and China looks likely to continue in 2022. The “<a href="https://www.piie.com/research/piie-charts/us-china-phase-one-tracker-chinas-purchases-us-goods">phase 1</a>” deal between the two nations, in which China had agreed to increase its purchases of certain US goods and services by a combined US$200 billion over 2020 and 2021 has missed its target <a href="https://www.piie.com/research/piie-charts/us-china-phase-one-tracker-chinas-purchases-us-goods">by about 40%</a> (as at the end of November). </p>
<p>The deal has now expired, and the <a href="https://www.globaltimes.cn/page/202201/1243977.shtml">big question</a> for international trade in 2022 is whether there will be a <a href="https://www.ced.org/solutions-briefs/the-china-trade-challenge-phase-ii">new “phase 2” deal</a>. It is hard to feel particularly optimistic here: Donald Trump may have long since left office, but US strategy on China remains <a href="https://www.project-syndicate.org/commentary/biden-losing-china-strategy-protectionism-industrial-policy-by-anne-o-krueger-2021-09?utm_source=Project%20Syndicate%20Newsletter&utm_campaign=bf7c015f95-sunday_newsletter_12_26_2021&utm_medium=email&utm_term=0_73bad5b7d8-bf7c015f95-105568073&mc_cid=bf7c015f95&mc_eid=14a09c8529&barrier=accesspaylog">distinctly Trumpian</a>, with no notable concessions having been offered to the Chinese under Joe Biden. </p>
<p>Elsewhere, western tensions with Russia over Ukraine and further escalation of economic sanctions against Putin may have economic consequences for the global economy – not least because of Europe’s dependency on Russian gas. The more engagement that we see on both fronts in the coming months, the better it will be for growth. </p>
<p>Whatever happens politically, it is clear that Asia will be very important for growth prospects in 2022. Major economies such as <a href="https://www.bloomberg.com/news/articles/2021-12-22/u-k-economy-closer-to-pre-pandemic-levels-despite-3q-downgrade?sref=Hjm5biAW">the UK</a>, <a href="https://tradingeconomics.com/japan/gdp">Japan</a> and the <a href="https://tradingeconomics.com/euro-area/gdp">eurozone</a> were all still smaller than before the pandemic as recently as the third quarter of 2021, the latest data available. The only major developed economy that has already recovered its losses and regained its pre-COVID size is <a href="https://www.brookings.edu/blog/up-front/2021/12/08/a-most-unusual-recovery-how-the-us-rebound-from-covid-differs-from-rest-of-g7/">the United States</a>. </p>
<p><strong>Economic growth by country since 2015</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/439333/original/file-20220104-18500-zchaq3.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/439333/original/file-20220104-18500-zchaq3.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/439333/original/file-20220104-18500-zchaq3.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=391&fit=crop&dpr=1 600w, https://images.theconversation.com/files/439333/original/file-20220104-18500-zchaq3.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=391&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/439333/original/file-20220104-18500-zchaq3.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=391&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/439333/original/file-20220104-18500-zchaq3.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=492&fit=crop&dpr=1 754w, https://images.theconversation.com/files/439333/original/file-20220104-18500-zchaq3.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=492&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/439333/original/file-20220104-18500-zchaq3.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=492&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">OECD data</span></span>
</figcaption>
</figure>
<p>On the other hand, China has <a href="https://www.worldometers.info/coronavirus/country/china/">managed the pandemic</a> well – albeit with strict control measures – and its economy has achieved strong growth since the second quarter of 2020. It has been <a href="https://theconversation.com/chinas-problem-with-property-the-domino-effect-of-evergrandes-huge-debts-168601">struggling with</a> a heavily over-indebted property market, but appears to have handled these problems <a href="https://www.wsj.com/articles/china-evergrande-says-construction-has-resumed-at-vast-majority-of-its-projects-11640602229">relatively smoothly</a>. Though the jury is out on the extent to which <a href="https://edition.cnn.com/2021/12/15/economy/china-omicron-economy-intl-hnk/index.html">China’s debt problems</a> will be a drag in 2022, some such as Morgan Stanley <a href="https://www.cnbc.com/2022/01/03/morgan-stanley-on-chinas-gdp-economy-in-2022.html">argue that</a> strong exports, accommodative monetary and fiscal policies, relief for real estate sector and a slightly more relaxed approach to carbon reduction point to a decent performance. </p>
<p>As for India, whose economy has seen double dips during the pandemic, it is showing a strong positive trend with <a href="https://www.imf.org/en/Publications/WEO/Issues/2021/10/12/world-economic-outlook-october-2021">8.5% expected growth</a> in the year ahead. I therefore suspect that emerging Asia will shoulder global growth in 2022, and the world’s <a href="https://onlinelibrary.wiley.com/doi/10.1111/j.1758-5899.2010.00066.x">economic centre of gravity</a> will continue to shift eastwards at an accelerated pace.</p><img src="https://counter.theconversation.com/content/174350/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>Will we now see a proper pandemic recovery?Muhammad Ali Nasir, Associate Professor in Economics and Finance, University of HuddersfieldLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1737922021-12-15T19:26:47Z2021-12-15T19:26:47ZWhat is the Fed taper? An economist explains how the Federal Reserve withdraws stimulus from the economy<figure><img src="https://images.theconversation.com/files/437844/original/file-20211215-13-1f16aed.jpg?ixlib=rb-1.1.0&rect=97%2C40%2C3717%2C2285&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">What goes up must come down.</span> <span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/illustration/upstairs-downstairs-icon-sign-man-walking-up-royalty-free-illustration/1164275698">iStock/Getty Images Plus</a></span></figcaption></figure><p><a href="https://www.cnbc.com/2021/11/03/fed-decision-taper-timetable-as-it-starts-pulling-back-on-pandemic-era-economic-aid-.html">Tapering</a> refers to the Federal Reserve policy of unwinding the massive purchases of Treasury bonds and mortgage-backed securities it’s been making to shore up the economy during the pandemic. </p>
<p>The unconventional monetary policy of buying assets is commonly known as <a href="https://www.investopedia.com/terms/q/quantitative-easing.asp">quantitative easing</a>. The Fed first <a href="https://www.stlouisfed.org/publications/regional-economist/third-quarter-2017/quantitative-easing-how-well-does-this-tool-work">adopted this policy during the 2008 financial crisis</a>.</p>
<p>Normally, when a central bank wants to reduce the cost of borrowing for companies and consumers, it lowers its target short-term interest rate. But <a href="https://corporatefinanceinstitute.com/resources/knowledge/economics/zero-lower-bound/">with its target rate at zero</a> during the 2008 crisis – at the same time that there was no inflation and the economy was still hurting – the Fed was no longer able to cut rates further. And so the Fed turned to quantitative easing as a way to continue to reduce borrowing costs. When the government buys assets, <a href="https://www.thebalance.com/why-do-bond-prices-and-yields-move-in-opposite-directions-417082">their prices go up</a>, which lowers their yield or interest rate.</p>
<p>The Fed again adopted this policy in March 2020 after the COVID-19 pandemic resulted in a national lockdown. By November 2021, the Fed had bought <a href="https://fred.stlouisfed.org/series/WALCL">over US$4 trillion worth</a> of <a href="https://fred.stlouisfed.org/series/TREAST">Treasurys</a> and <a href="https://fred.stlouisfed.org/series/WSHOMCB">other securities</a>. </p>
<p>The U.S. central bank began tapering in November 2021, <a href="https://www.federalreserve.gov/newsevents/pressreleases/monetary20211103a.htm">scaling back total purchases by $15 billion a month</a>, from $120 billion to $105 billion. The Fed <a href="https://www.federalreserve.gov/newsevents/pressreleases/monetary20211215a.htm">decided to double the pace at which it tapers</a> on Dec. 15. Rather than $15 billion, the Fed will reduce purchases by $30 billion every month. At that pace it will no longer be purchasing new assets by early 2022.</p>
<p><iframe id="vMS0F" class="tc-infographic-datawrapper" src="https://datawrapper.dwcdn.net/vMS0F/2/" height="400px" width="100%" style="border: none" frameborder="0"></iframe></p>
<h2>Why it matters</h2>
<p><a href="https://www.nytimes.com/2021/07/17/business/dealbook/inflation-questions-experts.html">Growing concerns among economists that rising inflation</a> could harm the economy are likely a big part of what led the Fed to begin tapering. </p>
<p><a href="https://theconversation.com/why-the-inflation-rate-doesnt-tell-the-whole-story-all-it-takes-is-a-spike-in-a-category-like-used-cars-to-cause-consumer-prices-to-soar-160849">Inflation</a> is the rate of change in the price of goods and services. The <a href="https://www.bls.gov/cpi/">Consumer Price Index</a>, which includes several categories of everyday items that a typical American might buy, is the measure of inflation most often reported in the media. In November 2021, <a href="https://www.bls.gov/news.release/cpi.nr0.htm">it was up 6.8% from a year earlier</a>. </p>
<p>By <a href="https://www.bea.gov/data/personal-consumption-expenditures-price-index">any measure</a>, inflation is above the <a href="https://www.federalreserve.gov/faqs/economy_14400.htm">Fed’s target of 2%</a>. By tapering asset purchases, the Fed may <a href="https://www.brookings.edu/blog/up-front/2021/07/15/what-does-the-federal-reserve-mean-when-it-talks-about-tapering/">help reduce inflation</a> – or at least slow its rise – because it is withdrawing some of the monetary stimulus that is fueling economic growth.</p>
<p>The reason the Fed has decided to accelerate the process is likely because <a href="https://www.reuters.com/markets/us/fed-prepares-stiffen-inflation-response-post-transitory-world-2021-12-15/">it now believes inflation may be less transitory than it had hoped</a>, at the same time that the <a href="https://www.reuters.com/markets/us/us-job-growth-likely-picked-up-unemployment-rate-seen-20-month-low-2021-12-03/">labor market appears strong</a>. </p>
<h2>What this means for you</h2>
<p>Americans <a href="https://fred.stlouisfed.org/series/FEDFUNDS">have enjoyed rock-bottom interest rates</a> for the better part of the past 13 years, helping to make it cheaper to borrow money to buy cars and homes and start businesses.</p>
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<p>Consumers and companies are already beginning to see slightly higher rates on <a href="https://fred.stlouisfed.org/series/MORTGAGE30US">mortgages</a>, business loans and <a href="https://www.cnbc.com/2021/11/03/the-fed-holds-rates-near-zero-heres-what-that-means-for-you.html">other types of borrowing</a>. </p>
<p>In other words, the era of cheap money may finally be coming to an end. Enjoy it while it lasts.</p>
<p><em>This is an updated version of <a href="https://theconversation.com/the-fed-tapers-its-support-for-bond-markets-and-the-economy-5-questions-answered-about-what-that-means-171151">an article originally published</a> on Nov. 3, 2021.</em></p><img src="https://counter.theconversation.com/content/173792/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Edouard Wemy does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Until recently the Federal Reserve had been purchasing roughly $120 billion of assets every month to support the US economy. The Fed began scaling back those purchases in November and doubled the pace on Dec. 15.Edouard Wemy, Assistant Professor of Economics, Clark UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1724372021-11-23T16:01:23Z2021-11-23T16:01:23ZThe euro is plunging – and probably won’t bounce back soon<figure><img src="https://images.theconversation.com/files/433475/original/file-20211123-15-17ld12v.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">E as in ebbing. </span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-illustration/weak-euro-currency-weakening-finances-man-341844767">kentoh/Shutterstock</a></span></figcaption></figure><p>The euro has weakened against the US dollar since the beginning of 2021, from around US$1.23 to its current exchange rate of US$1.13. That’s a fall of about 9%, which is significant, especially since these are the two major currencies of the world. The drop has also intensified in November, falling 3% since the turn of a month, which has seen violence in European capitals over COVID restrictions, migrant problems at the Belarus-Poland border and Russian troops amassing on the border of Ukraine. </p>
<p>The decline should be seen in a broader context, though. The euro is still stronger than a couple of years ago, when it was about US$1.10. It also went through some heavy weekly volatility from February to April 2020 in the early part of the COVID pandemic, bouncing between about US$1.07 and US$1.13 at a time when lots of investors were fleeing to the US dollar for safety and there was much uncertainty about what lockdowns would mean. </p>
<p><strong>Euro vs US dollar chart</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/433519/original/file-20211123-13-cymxib.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Euro vs dollar chart" src="https://images.theconversation.com/files/433519/original/file-20211123-13-cymxib.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/433519/original/file-20211123-13-cymxib.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=307&fit=crop&dpr=1 600w, https://images.theconversation.com/files/433519/original/file-20211123-13-cymxib.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=307&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/433519/original/file-20211123-13-cymxib.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=307&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/433519/original/file-20211123-13-cymxib.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=386&fit=crop&dpr=1 754w, https://images.theconversation.com/files/433519/original/file-20211123-13-cymxib.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=386&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/433519/original/file-20211123-13-cymxib.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=386&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.tradingview.com/symbols/EURUSD/">Trading View</a></span>
</figcaption>
</figure>
<p>Explaining currency movements on a weekly or even monthly basis is well known to be extremely difficult, especially when it comes to major economies like the US and the countries in the eurozone. But certainly we need to look at what is happening in both regions and not just one or the other. Using this simple idea, there are several explanations for the recent euro depreciation. </p>
<h2>Inflation differences</h2>
<p>The first explanation relates to the Federal Reserve and the European Central Bank (ECB) stimulating their economies using quantitative easing (QE), which is essentially creating money to buy financial assets such as government bonds from banks and other major investors. Both central banks have been doing this extensively since the start of the pandemic. </p>
<p>However, with annual inflation in the US now reaching a serious level <a href="https://news.sky.com/story/us-inflation-hits-highest-level-since-1990-at-6-2-as-food-and-fuel-prices-surge-12465340">of 6.2%</a>, compared with a <a href="https://www.reuters.com/world/europe/euro-zone-oct-inflation-confirmed-41-yy-energy-spike-2021-11-17/">less troublesome 4.1%</a> in the eurozone, the feeling is that the Fed will end its asset purchases sooner. This is because increasing the money supply has the potential to stoke inflation. Indeed, the Fed <a href="https://www.reuters.com/business/cop/dollar-hovers-near-peaks-fed-heads-taper-2021-11-03/">has recently</a> already started “tapering” or slowing down the rate of QE with a view to stopping it in the second half of 2022. On the other hand, the ECB <a href="https://www.bloomberg.com/news/articles/2021-10-06/ecb-said-to-study-new-bond-buying-plan-for-when-crisis-tool-ends">has been discussing</a> a replacement for its US$2.2 trillion (£1.7 trillion) QE programme when it ends in March 2022. </p>
<p>Connected to this is an <a href="https://www.bloomberg.com/news/articles/2021-11-18/jpmorgan-economists-now-predict-fed-to-raise-rates-in-september">increasing expectation</a> that the US may also have to begin a series of rises to interest rates from the middle of 2022 to curb inflation, while ECB president Christine Lagarde has just <a href="https://www.cnbc.com/2021/11/19/ecbs-lagarde-says-a-rate-hike-unlikely-for-2022.html">made it clear</a> that the ECB is unlikely to start raising rates until at least 2023. These emerging differences in the monetary-policy stances of the US and eurozone have clearly favoured a strengthening of the dollar (since QE and lower interest rates tend to make a currency depreciate). </p>
<h2>COVID and politics</h2>
<p>A second pivotal factor has been the recent relative strength of the US economy in its recovery from the pandemic compared with the eurozone. In 2021, the US <a href="https://www.imf.org/en/Publications/WEO/Issues/2021/10/12/world-economic-outlook-october-2021">is forecast</a> by the International Monetary Fund to grow 6% compared to 5% in the eurozone, while in 2022 they are respectively expected to grow 5.2% and 4.3%. Again, this points to dollar strength. </p>
<p>More COVID lockdowns in the US seem unlikely (even though cases are <a href="https://www.nytimes.com/2021/11/22/us/us-covid-cases-rising-thanksgiving.html?mc_cid=6d76cfd520&mc_eid=c825ac9090">rising again</a>), though not in the eurozone area, where the rate of infections has been picking up sharply in recent weeks in countries like Germany, France, the Netherlands, Austria and Belgium. Austria is <a href="https://www.bbc.com/news/world-europe-59369488">now back</a> in lockdown, <a href="https://news.sky.com/story/covid-19-germany-may-follow-austria-into-full-lockdown-as-coronavirus-cases-hit-new-high-12472233">and other</a> eurozone countries could follow suit. </p>
<p>A final driver of the recent strength of the dollar is greater political stability. The Biden administration still has three years in office and has recently succeeded in passing its US$1.7 trillion <a href="https://www.theguardian.com/us-news/2021/nov/19/house-democrats-pass-biden-expansive-build-back-better-policy-plan">Build Back Better</a> stimulus package. </p>
<p>By contrast, countries in the eurozone face a period of greater political instability. Germany is seeing the 16 years of relative stability under Angela Merkel coming to an end. <a href="https://www.thetimes.co.uk/article/french-election-2022-macron-is-sitting-pretty-but-sitting-presidents-often-tumble-fqfb6t5g0">The question</a> of whether Emmanuel Macron will succeed in the French elections in April 2022 against Marine Le Pen is also weighing on investors’ minds, as are the continued trade frictions between the EU and the UK over Brexit.</p>
<p>It is happening at a time when <a href="https://www.businessinsider.com/russian-invasion-of-ukraine-a-real-possibility-russia-watchers-warn-2021-11?r=US&IR=T">Russia’s build-up</a> of forces close to Ukraine raises the prospect of military conflict on the edge of Europe – not to mention that Russia <a href="https://www.reuters.com/markets/europe/living-hand-mouth-europes-gas-crunch-shows-little-sign-easing-2021-11-22/">has already</a> been limiting the region’s gas supply and one of its main pipelines runs through Ukraine. In addition, there have been significant <a href="https://www.buzzfeednews.com/article/skbaer/antivax-europe-covid-mandates">anti-vaccine protests</a> in France, the Netherlands, Germany and Italy, and European governments are now under <a href="https://thehill.com/opinion/finance/580976-is-europe-headed-toward-another-debt-crisis">intense pressure</a> to bring their spending under control. </p>
<p>So while short-term currency movements are very difficult to predict, there are many reasons to believe that the recent period of euro weakness will continue. This is making imports to the eurozone more expensive – not least energy – and while it has some benefits for a major exporter like Germany, it also undermines the credibility of the eurozone as a global economic force. </p>
<p>The gamechanger might be if the ECB acknowledged that there is an inflation problem that needs to be tackled, by ending its experiment with QE and beginning the process of raising interest rates. That, however, does not look likely any time soon.</p><img src="https://counter.theconversation.com/content/172437/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Keith Pilbeam 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>To understand the euro’s weakness, you have to look at the US as well as Europe.Keith Pilbeam, Professor of Economics, City, University of LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1711512021-11-03T21:19:50Z2021-11-03T21:19:50ZThe Fed tapers its support for bond markets and the economy – 5 questions answered about what that means<figure><img src="https://images.theconversation.com/files/430104/original/file-20211103-16987-2r5k2n.jpg?ixlib=rb-1.1.0&rect=12%2C44%2C4181%2C2747&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Fed Chair Jerome Powell prepares for the end of the era of cheap money. </span> <span class="attribution"><a class="source" href="https://newsroom.ap.org/detail/SenateCARESAct/5bf74a9d8d90464094551adcd4d611cc/photo?Query=Jerome%20powell&mediaType=photo&sortBy=arrivaldatetime:desc&dateRange=Anytime&totalCount=1276&currentItemNo=57">Matt McClain/The Washington Post via AP</a></span></figcaption></figure><p><em>The Federal Reserve on Nov. 3, 2021, <a href="https://www.bloomberg.com/news/articles/2021-11-03/fed-to-start-tapering-asset-buys-by-15-billion-later-this-month">said it is winding down</a> the bond-buying program it’s had in place since March 2020. The Fed’s policy-setting committee <a href="https://www.federalreserve.gov/newsevents/pressreleases/monetary20211103a.htm">said it would immediately “taper”</a> asset purchases by US$15 billion each month. The central bank <a href="https://fred.stlouisfed.org/series/WALCL">had been buying $120 billion a month worth</a> of Treasury bonds and mortgage-backed securities to fight the effects of the COVID-19 pandemic and shore up the U.S. economy.</em> </p>
<p><em>We asked Clark University economist <a href="https://www2.clarku.edu/faculty/facultybio.cfm?id=1080">Edouard Wemy</a> to explain the Fed’s tapering policy and why it matters.</em> </p>
<h2>1. What is tapering?</h2>
<p><a href="https://www.cnbc.com/2021/11/03/fed-decision-taper-timetable-as-it-starts-pulling-back-on-pandemic-era-economic-aid-.html">Tapering</a> refers to the policy of unwinding the massive purchases of Treasuries and mortgage-backed securities adopted by the Fed since the outbreak of COVID-19. Since March, the Fed has bought over $4 trillion worth of <a href="https://fred.stlouisfed.org/series/TREAST">Treasurys</a> and <a href="https://fred.stlouisfed.org/series/WSHOMCB">other securities</a> in what is commonly known as quantitative easing. </p>
<p>The Fed says it will reduce purchases of Treasury bonds by $10 billion a month from $80 billion in October and mortgage-backed securities by $5 billion from $40 billion. That means, for example, the Fed will buy $70 billion of Treasurys in November and $60 billion in October. While the Fed said it may change the pace of the drawdown, if it continues at this pace it’ll stop buying new assets by mid-2022. </p>
<h2>2. What is quantitative easing?</h2>
<p><a href="https://www.investopedia.com/terms/q/quantitative-easing.asp">Quantitative easing</a> is an unconventional monetary policy tool that consists of the large-scale purchase of various types of assets, including Treasurys, corporate bonds and other securities. </p>
<p>The Fed first <a href="https://www.stlouisfed.org/publications/regional-economist/third-quarter-2017/quantitative-easing-how-well-does-this-tool-work">adopted this policy during the 2008 financial crisis</a> after it <a href="https://www.vox.com/2014/6/20/18079946/fed-vs-crisis">dropped its benchmark interest rate</a> – its main policy tool for affecting short-term market borrowing costs and therefore the overall economy – to virtually zero. </p>
<p>But with its benchmark rate at zero – at the same time that there was no inflation and the economy was still hurting – the Fed was no longer able to use its main policy lever to support workers and stimulate economic growth by making it cheaper to borrow. And so the Fed turned to quantitative easing as a way to continue to provide credit to the economy and further lower borrowing costs for companies and consumers. By buying assets, their price goes up, which lowers their yield or interest rate.</p>
<h2>3. Why is the Fed tapering now?</h2>
<p><a href="https://www.nytimes.com/2021/07/17/business/dealbook/inflation-questions-experts.html">Growing concerns that rising inflation</a> could harm the economy are likely a big part of what led the Fed to change its policy.</p>
<p><a href="https://theconversation.com/why-the-inflation-rate-doesnt-tell-the-whole-story-all-it-takes-is-a-spike-in-a-category-like-used-cars-to-cause-consumer-prices-to-soar-160849">Inflation</a> is the rate of change in the price of goods and services. The <a href="https://www.bls.gov/cpi/">Consumer Price Index</a>, which includes several categories of everyday items that a typical consumers may buy, is the measure of inflation most often reported in the media. By October 2021, <a href="https://www.bls.gov/news.release/cpi.nr0.htm">it was up 5.4% from a year earlier</a>. </p>
<p>However, the Fed typically prefers the core <a href="https://www.bea.gov/data/personal-consumption-expenditures-price-index">Personal Consumption Expenditures</a> measure of inflation because, unlike the CPI, it excludes volatile food and energy prices. This other measure, usually lower than the CPI, has climbed a little less, or 4.4% over about the same period</p>
<p>But both measures have been above the <a href="https://www.federalreserve.gov/faqs/economy_14400.htm">Fed’s target of 2%</a> annual inflation in recent months. Many observers have viewed this upward trend as an indication that the Fed <a href="https://www.cnbc.com/2021/06/16/fed-holds-rates-steady-but-raises-inflation-expectations-sharply-and-makes-no-mention-of-taper.html">might even have to increase interest rates soon</a> – something that could lead to slower economic growth.</p>
<p>In its Nov. 3 statement, the Fed cited signs the U.S. economy is strengthening, “progress on vaccinations” and elevated inflation as key considerations as it began pulling back, a little, on its asset purchases. But the Fed also emphasized that it intends to keep an “accommodative” stance on monetary policy – meaning it will keep up its support in terms of low interest rates and other measures – until it achieves maximum employment and price stability. </p>
<p>The recent increase in consumer prices may be driven by transitory factors tied to the pandemic, like increases in the cost of used cars, higher consumer demand and supply chain problems. <a href="https://www.reuters.com/business/with-bond-buying-taper-bag-fed-turns-wary-eye-inflation-2021-11-03/">That’s how the Fed sees it</a>, for now, and it will be watching inflation closely in the coming months. </p>
<h2>4. Could this mean a rise in interest rates soon?</h2>
<p>Consumers and companies are already beginning to see slightly higher rates on <a href="https://fred.stlouisfed.org/series/MORTGAGE30US">mortgages</a>, business loans and <a href="https://www.cnbc.com/2021/11/03/the-fed-holds-rates-near-zero-heres-what-that-means-for-you.html">other types of borrowing</a>. </p>
<p>At the same time, <a href="https://www.bloomberg.com/news/articles/2021-10-30/goldman-now-sees-fed-hiking-rates-in-july-as-inflation-lingers">investors are expecting</a> the Fed to <a href="https://www.treasury.gov/resource-center/data-chart-center/interest-rates/pages/TextView.aspx?data=yieldYear&year=2021">hike its own benchmark interest rate</a> sooner than planned. The <a href="https://www.marketwatch.com/story/fed-officials-say-tapering-may-soon-be-warranted-and-pencil-in-an-earlier-rate-hike-11632333636">Fed also changed its timetable</a> for interest rate increases to 2022 from 2023.</p>
<h2>5. How will this affect consumers?</h2>
<p>Consumers <a href="https://fred.stlouisfed.org/series/FEDFUNDS">have enjoyed rock-bottom interest rates</a> for the better part of the past 13 years, helping make it cheaper to buy cars and homes and start businesses.</p>
<p>Higher interest rates – whether as a result of the Fed’s buying fewer assets or the market’s simply anticipating higher rates – would of course increase the cost of borrowing for mortgages and cars loans, which in turn can slow economic activity. </p>
<p>At the same time, a small rise in rates may have other positive effects for some consumers. For example, it could cool down the housing market, which would make it easier for some people to buy a home. </p>
<p>One way or another, it seems the Nov. 3 policy change may signal the era of cheap money may finally be coming to an end – but still not for a while, so enjoy it while it lasts.</p>
<p>[<em>Over 115,000 readers rely on The Conversation’s newsletter to understand the world.</em> <a href="https://theconversation.com/us/newsletters/the-daily-newsletter-3?utm_source=TCUS&utm_medium=inline-link&utm_campaign=newsletter-text&utm_content=100Ksignup">Sign up today</a>.]</p><img src="https://counter.theconversation.com/content/171151/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Edouard Wemy does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The Federal Reserve decided to slow its pace of bond-buying, potentially the beginning of the end of a program that’s been supporting the economy since March 2020.Edouard Wemy, Assistant Professor of Economics, Clark UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1681062021-09-16T14:59:28Z2021-09-16T14:59:28ZRising inflation: unless we act now, it will not be temporary<figure><img src="https://images.theconversation.com/files/421585/original/file-20210916-21-1h8nn56.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Up she goes. </span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-illustration/food-price-increase-grocery-bill-rise-1250958577">Lightspring</a></span></figcaption></figure><p>Consumer price inflation in the UK <a href="https://www.theguardian.com/business/2021/sep/15/uk-inflation-in-record-august-jump-as-food-and-drink-prices-rise">rose by 3.2%</a> year on year in August, the highest annual rise in nearly a decade. This was 1.2 percentage points above the July number, making it the biggest month-on-month rise since records began in 1997. Inflation is also an issue far beyond the UK: <a href="https://tradingeconomics.com/united-states/inflation-cpi">in the US</a>, it is currently running at 5.3%, for instance. </p>
<p>Bank of England economists <a href="https://www.ft.com/content/144460b0-887a-408f-89b6-e629cadd617f">conveniently attribute</a> these hefty rises to temporary factors and claim that inflation will soon stop rising in the UK without much intervention. They point out that prices a year ago were artificially subdued and as they returned to more “normal” levels, we were destined to get high measures of inflation. </p>
<p>One example would be <a href="https://www.racfoundation.org/data/uk-pump-prices-over-time">petrol prices</a>. Subdued demand for commuting helped to lower them to about 113p per gallon at the pump in 2020, yet as travel returned to pre-pandemic levels, increased demand for petrol has pushed prices to around 135p. Or you could look at the <a href="https://theconversation.com/eat-out-to-help-out-crowded-restaurants-may-have-driven-uk-coronavirus-spike-new-findings-145945">Eat Out to Help Out</a> scheme, which lowered the prices people paid in restaurants in summer 2020. As the scheme ended, prices hiked suddenly, which increased inflation. </p>
<p>The argument from the optimists is that these one-off shifts will wash through the system and prices will stabilise at their current levels. Yet not all price hikes can be attributed to temporary factors. There are also deeper, structural factors at play.</p>
<h2>What causes inflation</h2>
<p>Inflation is measured by the Office for National Statistics, which records the prices of thousands of products. These prices are defined by a never-ending interplay between supply and demand in the economy (assuming the government doesn’t intervene to fix prices in some way). </p>
<p>An abundance of excess produce or services means that prices are likely to fall, as we saw with petrol prices. On the other hand, demand for products that can’t be fully satisfied by the supply usually pushes prices higher. This happened with <a href="https://www.chargedretail.co.uk/2020/07/06/hand-sanitiser-prices-400-on-average-during-height-of-pandemic-as-cma-warns-price-gougers/">hand sanitisers</a> in 2020, for instance, and more recently with <a href="https://www.ft.com/content/f32ea2ee-bc7b-44ff-b276-0a68275d01ae">second-hand cars</a>.</p>
<p><strong>Ten years of UK inflation</strong></p>
<p>Besides COVID, Brexit has certainly affected prices. It has <a href="https://www.theguardian.com/business/2021/jun/26/recipe-for-inflation-how-brexit-and-covid-made-tinned-tomatoes-a-lot-dearer">rendered trade</a> with the UK’s neighbouring countries more difficult and expensive. This is contributing to shortages of products, pushing prices up. </p>
<p>Brexit has also hindered production in the UK by alienating a percentage of EU nationals working in the country. <a href="https://theconversation.com/three-things-that-could-help-save-christmas-2021-from-shortages-167072">Shortages of</a> fruit pickers, lorry drivers and NHS nurses have been pushing wages higher and making UK production more expensive. And there is the potential for more political and trade disruptions between the UK and EU, not least over <a href="https://theconversation.com/irish-sea-border-trust-is-the-biggest-problem-for-the-northern-ireland-protocol-164355">Northern Ireland</a>, which could make products and production even more expensive.</p>
<p>Another structural factor relevant to inflation is the British pound. The UK imports hundreds of billions of pounds worth of consumer products and raw materials. A lower pound sees the country paying more of its currency to purchase products from abroad, making these products more expensive in pounds. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/421588/original/file-20210916-23-1tatcm6.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Woman holding an open purse in one hand and a pound coin in the other." src="https://images.theconversation.com/files/421588/original/file-20210916-23-1tatcm6.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/421588/original/file-20210916-23-1tatcm6.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/421588/original/file-20210916-23-1tatcm6.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/421588/original/file-20210916-23-1tatcm6.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/421588/original/file-20210916-23-1tatcm6.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/421588/original/file-20210916-23-1tatcm6.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/421588/original/file-20210916-23-1tatcm6.jpeg?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">Doesn’t buy you much these days.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/hands-holding-british-pound-coin-small-369962102">Yulia Grigoryeva</a></span>
</figcaption>
</figure>
<p><a href="https://theconversation.com/brexit-uk-pound-has-not-crashed-yet-but-heres-why-it-will-probably-suffer-in-years-to-come-152646">The pound</a> has already been weakening against its rivals for several years due to economic factors like weaker productivity. This falling trajectory is also likely to continue due to political factors such as the looming second Scottish independence referendum and civil unrest in Northern Ireland. </p>
<p>Also, as the Bank of England keeps turbocharging the economy with vast amounts of money through <a href="https://www.ft.com/content/da550a79-5284-4bc1-96f9-f0eb8b6fed33">quantitative easing (QE)</a>, there should be downwards pressure on the value of the pound. The only thing that spares the pound from big falls is the fact that central banks of other major currencies are doing the same – for the time being. </p>
<p>Loose monetary policy also potentially contributes to higher inflation for another reason. Record low interest rates encourage consumers to borrow, while <a href="https://www.economicsonline.co.uk/Global_economics/Quantitative_easing.html#:%7E:text=QE%20can%20work%20in%20a,wealth%20effect%20for%20asset%20holders.">QE encourages banks</a> to lend more, since it boosts the value of the assets on their balance sheets. This can fuel demand for products such as cars, electronics and white goods (such as washing machines, dishwashers and fridges). Indicatively, though house prices are (wrongly) not counted in consumer price inflation, low interest rates <a href="https://www.bbc.co.uk/news/business-15198789">have contributed</a> to substantially higher prices in that market, as well as in <a href="https://tradingeconomics.com/united-kingdom/stock-market">stock market shares</a>.</p>
<h2>Where we go from here</h2>
<p>A little inflation in an economy can be positive, to the extent that it spurs consumers to buy things before the price rises. It is also a way of lowering the government’s debts in real terms, which is attractive after the <a href="https://tradingeconomics.com/united-kingdom/government-debt-to-gdp">massive borrowing</a> to pay for the COVID stimulus package. </p>
<p>High inflation is a problem, though, as it erodes people’s real incomes, meaning they consume less and businesses make less money. This is why the Bank of England was granted independence from the UK government in the 1990s, with a mandate to keep inflation around 2%. </p>
<p>The UK government and Bank of England should therefore work to address some of the longer term, structural factors which can pin inflation consistently high –particularly when “supply shocks” like a new COVID variant or trade sanctions on China could further imbalance supply and demand in the short to medium term. </p>
<p>Shortages of people and skills in the labour market must be addressed before the production capacity of the UK <a href="https://www.theguardian.com/politics/2021/jan/30/uk-firms-plan-to-shift-across-channel-after-brexit-chaos">is scarred</a> by more businesses relocating and outsourcing production. Through Brexit, the UK public voted to take control of migration, not shut it down when it’s needed. </p>
<p>Free trade in products and services with UK’s neighbouring continent is also paramount for the country’s long-term competitiveness, but here things are admittedly difficult. The EU will never accept the existential danger of a country benefiting from its massive free market without fully subscribing to its policies and regulations. Damage control seems to be the only way forward here, which underlines the importance of reaching a lasting agreement with the EU over Northern Ireland. </p>
<p>Finally, the Bank of England should consider taking its foot off the QE accelerator sooner rather than later, before inflation expectations <a href="https://www.theguardian.com/business/2021/may/13/top-bank-of-england-economist-warns-of-1970s-style-price-inflation">are crystallised</a> into further price increases. Money that is too abundant and ultra-low interest rates not only inflate asset prices but also boost corporate borrowing and provide a temporary lifeline to <a href="https://theconversation.com/concern-is-mounting-about-zombie-companies-why-that-matters-for-the-economic-recovery-158554">zombie companies</a>, laying the groundwork for the next crisis.</p><img src="https://counter.theconversation.com/content/168106/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alexander Tziamalis 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>Inflation in the UK in August rose at the highest rate in a decade.Alexander Tziamalis, Senior Lecturer in Economics, Sheffield Hallam 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>
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<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/1638052021-07-06T07:34:18Z2021-07-06T07:34:18ZRBA starts three-year countdown to lift in interest rates<p>In line with expectations, the Reserve Bank of Australia has announced it will keep official interest rates on hold at 0.10%.</p>
<p>But is also ready to start tapering off its “unconventional” monetary policy measures introduced in response to the COVID-19 economic crisis.</p>
<p>These measures, designed to stimulate spending by keeping interest rates low for the next few years, have had two key components, </p>
<p>1) The “Yield Curve Control program” — involving the bank buying government bonds to keep interest rates at 0.1% for the next three years.</p>
<p>2) Quantitative Easing – involving the RBA buying long-term government bonds to help keep interest rates low over the five to ten years, but without a fixed goal for interest rates.</p>
<p>These measures will be wound back slowly. </p>
<p>Following the Reserve Bank board’s July meeting, at which these decisions were made, governor <a href="https://www.rba.gov.au/media-releases/2021/mr-21-13.html">Philip Lowe said </a>the Yield Curve Control program would end in April 2024 (the bank had been considering extending it to November 2024). The bond buying will continue but at a lower rate – at $4 billion a week rather than $5 billion. </p>
<h2>A monetary policy dilemma</h2>
<p>Heading into the meeting, the bank’s directors faced a dilemma. They knew the economy still required more support. Inflation remains below the target band. Unemployment is still too high. Lockdowns continue to periodically shutter large swathes of the economy. </p>
<p>Lowe has long promised the RBA won’t lift interest rates until inflation is back within its target band. He reiterated this today: “It will not increase the cash rate until actual inflation is sustainably within the 2-3% target range.”</p>
<p>It is not enough for inflation to be forecast in this range. The RBA wants to see results before it changes rates. </p>
<p>That still seems a long way off, with the central bank expecting the underlying inflation to be 1.5% over 2021, rising to 2% by mid-2023.</p>
<p>It maintains the key to getting wages and inflation higher is a stronger labour market. While unemployment is now at 5.1%, with underemployment also falling, that’s still a long way from “full employment”, which economists broadly agree is about 4.5-4.75%.</p>
<hr>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/409840/original/file-20210706-23-xrsme6.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/409840/original/file-20210706-23-xrsme6.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/409840/original/file-20210706-23-xrsme6.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=350&fit=crop&dpr=1 600w, https://images.theconversation.com/files/409840/original/file-20210706-23-xrsme6.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=350&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/409840/original/file-20210706-23-xrsme6.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=350&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/409840/original/file-20210706-23-xrsme6.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=440&fit=crop&dpr=1 754w, https://images.theconversation.com/files/409840/original/file-20210706-23-xrsme6.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=440&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/409840/original/file-20210706-23-xrsme6.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=440&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="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
</figcaption>
</figure>
<hr>
<h2>This starts the countdown to lift-off</h2>
<p>Despite the still mediocre state of the economy, there has been rising concern the central bank’s stated commitment to keep interest rates at 0.1% until late 2024 would be risky if the economy continued to quickly improve as it has done over the past six months.</p>
<p>So the board’s solution to this dilemma is to wind back some of the unconventional monetary policy measures, in small bite-size chunks. </p>
<p>By doing this gradually, the RBA hopes to avoid a panic in the financial markets of the sort that occurred in the United States during the “Taper Tantrum” of 2013, when the US Federal Reserve announced it would start to wind back the quantitative easing programs first deployed in response to the Global Financial Crisis of 2007-08.</p>
<p>Today thus officially starts a three-year countdown to when we can expect interest rates to gradually lift off. </p>
<h2>Steady as she goes</h2>
<p>By continuing its quantitative easing program – albeit at the lower rate of buying A$4 billion of government bonds each week – the RBA will help keep long-term interest rates low.</p>
<p>This policy combination allows the bank to continue supporting the economy today with flexibility down the road to lift interest rates if and when appropriate.</p>
<p>If these optimistic forecasts do not pan out and the economy slows in the months ahead, the RBA has made it clear it will step back in with more support.</p>
<p>This dovish response will be good news for home owners and sellers. Low interest rates will likely see strong buyer demand continue. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/vital-signs-its-not-the-reserve-banks-job-to-worry-about-housing-prices-162499">Vital Signs: It's not the Reserve Bank's job to worry about housing prices</a>
</strong>
</em>
</p>
<hr>
<p>The RBA has said housing affordability is not an issue for it to resolve, but <a href="https://www.rba.gov.au/media-releases/2021/mr-21-13.html#:%7E:text=Given%20the%20environment%20of%20rising,that%20lending%20standards%20are%20maintained.&text=The%20Bank's%20central%20scenario%20for,not%20be%20met%20before%202024.">Lowe promised</a> it “will be monitoring trends in housing borrowing carefully and it is important that lending standards are maintained.”</p><img src="https://counter.theconversation.com/content/163805/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>The Reserve Bank of Australia is ready to taper off the ‘unconventional’ monetary policy measures introduced in response to the COVID-19 crisis.Isaac Gross, Lecturer in Economics, Monash UniversityLicensed 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/1590342021-05-04T14:23:13Z2021-05-04T14:23:13ZThe Bank of Canada must seize the pandemic moment and do more for Canadians<figure><img src="https://images.theconversation.com/files/398428/original/file-20210503-19-1f00981.jpg?ixlib=rb-1.1.0&rect=0%2C0%2C3751%2C2645&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">A woman walks past the Bank of Canada building in Ottawa in September 2017. </span> <span class="attribution"><span class="source">THE CANADIAN PRESS/Adrian Wyld</span></span></figcaption></figure><p>The <a href="https://www.bankofcanada.ca/">Bank of Canada</a>, like central banks around the world, is currently facing enormous upheaval and uncertainty due to the enduring COVID-19 pandemic. </p>
<p>Will its leadership seize the moment as an opportunity to innovate and respond to the challenges ahead, including rising inequality and climate change? Or will it treat the present crisis as a temporary exception, hoping to return to business as usual once the pandemic recedes?</p>
<p>This spring, the bank released the <a href="https://www.bankofcanada.ca/toward-2021-renewing-the-monetary-policy-framework/toward-2021-outreach/lets-talk-inflation/consultations-with-canadians/">results of its consultations with Canadians</a> as part of its ongoing mandate review. This is an historic opportunity for our central bank and the federal government to make the bank work better for the Canadian people.</p>
<p>As academics specializing in philosophy and economics, and politics, respectively, we’d like to highlight two key themes that emerged in the Bank of Canada’s consultations with Canadians.</p>
<h2>Wealth inequality, climate action</h2>
<p>First, many Canadians are deeply concerned about the increasingly unequal distribution of wealth in this country — particularly by the way it has been driven by <a href="https://www.cbc.ca/news/canada/photos/canada-real-estate-prices-scroller-1.6004260">skyrocketing house prices.</a> Second, some Canadians would like to see the Bank of Canada take the threat of climate change seriously as it plays its key role in ensuring price and financial stability.</p>
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Read more:
<a href="https://theconversation.com/climate-action-job-creation-are-top-post-pandemic-priorities-for-canadians-156739">Climate action, job creation are top post-pandemic priorities for Canadians</a>
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<p>How could the bank do better in tackling these two core problems — the scourge of rising inequality and the future shocks of climate change?</p>
<p>On inequality, there are many useful models around the world. Although Canadians like to think we’re more progressive than our neighbour to the south, American are actually well ahead of us in rethinking the role of their central bank. </p>
<p><a href="https://www.federalreserve.gov/newsevents/speech/powell20200827a.htm">The United States Federal Reserve’s recent shift towards what’s known as average inflation targeting,</a> a strategy that seeks to balance inflation and growth over the medium term, gives it more flexibility to boost employment.</p>
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<img alt="'The Bank of Canada' is etched onto a stone wall." src="https://images.theconversation.com/files/398426/original/file-20210503-19-1joypcg.jpg?ixlib=rb-1.1.0&rect=0%2C533%2C5476%2C3009&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/398426/original/file-20210503-19-1joypcg.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=387&fit=crop&dpr=1 600w, https://images.theconversation.com/files/398426/original/file-20210503-19-1joypcg.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=387&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/398426/original/file-20210503-19-1joypcg.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=387&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/398426/original/file-20210503-19-1joypcg.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=486&fit=crop&dpr=1 754w, https://images.theconversation.com/files/398426/original/file-20210503-19-1joypcg.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=486&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/398426/original/file-20210503-19-1joypcg.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=486&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">The Bank of Canada in Ottawa in December 2020.</span>
<span class="attribution"><span class="source">THE CANADIAN PRESS/Sean Kilpatrick</span></span>
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</figure>
<p>Such a strategy, if combined with a dual mandate of price stability and employment, would allow the Bank of Canada to pay more attention to the needs of all Canadians. The bank’s public consultations suggest there’s in fact considerable support for such a move.</p>
<p>While this would be a first and important step in modernizing the Bank of Canada’s mandate, we need to go further and take a more careful look at some of the policy tools that the central bank has been using in the last year. </p>
<h2>Quantitative easing</h2>
<p>Since the COVID-19 crisis took hold, the Bank of Canada joined other central banks in engaging in what’s called <a href="https://www.bankofcanada.ca/2020/12/how-quantitative-easing-works/">quantitative easing</a>, initiating massive purchases of financial assets. As a result, its <a href="https://www.bankofcanada.ca/2019/08/bank-canada-balance-sheet/">balance sheet has increased by close to 500 per cent since March 2020</a>.</p>
<p>Such liquidity injections by central banks are clearly necessary. The question is <em>how</em> this liquidity should be injected.</p>
<p>Suppose your doctor prescribes you a drug that is known to have serious side effects. Wouldn’t you want her to look into alternative treatments? The experience with quantitative easing since 2008 shows that it has two serious side effects, both of which pertain to some of the core concerns of Canadians.</p>
<p>First, it exacerbates inequality. While the central bank may want to see a good portion of the injected liquidity used to stimulate real economic activity, this is not something it can control. Instead, a lot of the liquidity has ended up in stock markets and housing markets, benefiting wealthy asset owners and helping to push the cost of owning a house beyond the means of many Canadians.</p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/398463/original/file-20210503-15-1llm6fr.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Mark Carney gestures." src="https://images.theconversation.com/files/398463/original/file-20210503-15-1llm6fr.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/398463/original/file-20210503-15-1llm6fr.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=370&fit=crop&dpr=1 600w, https://images.theconversation.com/files/398463/original/file-20210503-15-1llm6fr.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=370&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/398463/original/file-20210503-15-1llm6fr.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=370&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/398463/original/file-20210503-15-1llm6fr.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=465&fit=crop&dpr=1 754w, https://images.theconversation.com/files/398463/original/file-20210503-15-1llm6fr.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=465&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/398463/original/file-20210503-15-1llm6fr.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=465&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">Mark Carney, then the governor of the Bank of England, speaks at a news conference in December 2019.</span>
<span class="attribution"><span class="source">(AP Photo/Kirsty Wigglesworth)</span></span>
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</figure>
<p>As Mark Carney, then governor of the Bank of England, acknowledged in 2014, “<a href="https://www.bis.org/review/r140528b.htm">the distributional consequences of the response to the financial crisis have been significant</a>.” The same is true today.</p>
<p>Second, when quantitative easing includes buying corporate bonds, it facilitates access to capital markets for the firms in question. Central banks appeal <a href="https://www.cepweb.org/central-bank-market-neutrality-is-a-myth/">to the idea of “market neutrality”</a> and claim that an asset purchase that reflects current bond volumes on capital markets does not favour anyone in particular.</p>
<p>But in countries like Canada, when you <a href="https://www.investopedia.com/articles/investing/062813/why-companies-issue-bonds.asp">buy a collection of corporate bonds</a> compared to <a href="https://www.reference.com/business-finance/outstanding-bonds-836fc7a1b6253cbf#:%7E:text=Outstanding%20bonds%20are%20those%20bonds,the%20company%20to%20the%20investor.&text=Interest%20is%20to%20be%20returned,those%20bonds%20are%20considered%20paid.">the outstanding bonds on the market</a>, you inevitably reinforce the status quo with its many companies that have large carbon footprints. That slows the transition to a more sustainable economy.</p>
<h2>Politics comes with the territory</h2>
<p>Some will caution that independent central banks should not get involved with such deeply political issues. The answer to this is simply: It’s too late for that. Political decisions come with the territory of central banking today, and we’d better develop innovative policy instruments to reflect this reality.</p>
<p>Other central banks are adapting already. In December, the <a href="https://www.snb.ch/en/mmr/speeches/id/ref_20201217_tjn/source/ref_20201217_tjn.en.pdf">Swiss National Bank announced</a> that its asset purchases will exclude all companies primarily active in coal mining. </p>
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<a href="https://images.theconversation.com/files/398465/original/file-20210503-15-caex5k.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Christine Lagarde addresses European lawmakers" src="https://images.theconversation.com/files/398465/original/file-20210503-15-caex5k.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/398465/original/file-20210503-15-caex5k.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/398465/original/file-20210503-15-caex5k.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/398465/original/file-20210503-15-caex5k.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/398465/original/file-20210503-15-caex5k.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/398465/original/file-20210503-15-caex5k.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/398465/original/file-20210503-15-caex5k.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">Christine Lagarde, European Central Bank president, addresses European lawmakers in Brussels in February 2021.</span>
<span class="attribution"><span class="source">(AP Photo/Olivier Matthys)</span></span>
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</figure>
<p>Perhaps more significantly, the <a href="https://www.ecb.europa.eu/home/html/index.en.html">European Central Bank</a> has vowed to take a more active stance on climate change since Christine Lagarde has taken over as president.</p>
<p>Unconventional policies can also be used to alleviate — instead of exacerbate — inequality. One idea is to transfer money to citizens through <a href="https://www.investopedia.com/articles/personal-finance/082216/what-difference-between-helicopter-money-and-qe.asp">so-called helicopter money</a> rather than rely on institutional investors to transform quantitative easing measures into economic stimulus initiatives. The policy response to COVID-19, particularly <a href="https://www.cbc.ca/news/politics/cerb-ei-benefits-covid19-1.5743537">the Canadian Emergency Response Benefit (CERB)</a>, actually provides an interesting blueprint for this.</p>
<p>The overall tone of the Bank of Canada’s consultations report seems to suggest that the institution is more comfortable with the status quo than with serious innovation. </p>
<p>But our central bank actually has <a href="https://www.bankofcanada.ca/2000/10/can-a-bank-change/">a history of being an innovator in monetary policy</a>. In 1975, it was among the first central banks to <a href="https://www.imf.org/external/pubs/ft/fandd/2014/03/basics.htm">adopt monetarism</a>, the practice of controlling the money supply to stabilize the economy. And it was the second to adopt <a href="https://www.bankofcanada.ca/2020/08/understanding-inflation-targeting/#:%7E:text=After%20trying%20a%20few%20different,in%20good%20overall%20economic%20performance.">inflation targeting</a> in 1991, when it was still an untested approach. </p>
<p>To confront today’s many challenges, the Bank of Canada needs to rediscover that innovative zeal.</p><img src="https://counter.theconversation.com/content/159034/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Peter Dietsch receives funding from the Social Sciences and Humanities Research Council of Canada. He is a member of the advisory board of the Council on Economic Policies. </span></em></p><p class="fine-print"><em><span>Jacqueline Best receives funding from the Social Sciences and Humanities Research Council of Canada.</span></em></p>Unconventional policies can be used to alleviate — instead of exacerbate — inequality, something Canadians are clamouring for. The Bank of Canada needs to rediscover its former innovation zeal.Peter Dietsch, Professor, Département de Philosophie, Université de MontréalJacqueline Best, Professor of Political Studies, L’Université d’Ottawa/University of OttawaLicensed 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>
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<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/1563482021-03-11T14:53:38Z2021-03-11T14:53:38ZDysfunctional financial markets are making inequality worse all the time – here’s what to do about it<figure><img src="https://images.theconversation.com/files/389048/original/file-20210311-23-165qfpa.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Winners and losers. </span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/miniature-business-man-standing-on-pile-1907977396">Tama2u</a></span></figcaption></figure><p>The global market in government bonds has been bleeding red lately. “Bond market screams for help but no one answers”, says <a href="https://www.bloomberg.com/opinion/articles/2021-02-25/bond-market-screams-for-help-but-no-one-answers">Bloomberg</a>. It is “the worst start to a year in bonds since 2015”, according to the <a href="https://www.ft.com/content/ff064e39-a153-4817-be6f-92d23614dfeb">Financial Times</a>. </p>
<p>Though bonds have been declining since last summer, the sell-off became a lot more violent in February. This meant that the yield on ten-year US Treasury bonds, which is inversely related to the price, rose by around 60% to peak at over 1.6% a couple of days ago, before falling back to 1.5% at the time of writing. </p>
<p><strong>US 10-year bond yields</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/389028/original/file-20210311-14-kvvdlc.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Ten year chart of price of ten-year US treasury yields" src="https://images.theconversation.com/files/389028/original/file-20210311-14-kvvdlc.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/389028/original/file-20210311-14-kvvdlc.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=351&fit=crop&dpr=1 600w, https://images.theconversation.com/files/389028/original/file-20210311-14-kvvdlc.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=351&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/389028/original/file-20210311-14-kvvdlc.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=351&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/389028/original/file-20210311-14-kvvdlc.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=441&fit=crop&dpr=1 754w, https://images.theconversation.com/files/389028/original/file-20210311-14-kvvdlc.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=441&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/389028/original/file-20210311-14-kvvdlc.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=441&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.tradingview.com/chart/?symbol=TVC%3AUS10Y">Trading View</a></span>
</figcaption>
</figure>
<p>The US ten-year strongly influences the price of everything from mortgages to business loans in the US, and by extension around the world, so such a sharp rise has the potential to reduce borrowing and weaken the economic recovery from COVID –especially when there is so much debt in the global system. The world’s rampant stock markets responded by going into reverse in February as they factored in higher interest rates, as well as higher production costs because of surging <a href="https://www.tradingview.com/symbols/SP-SPGSCI/">commodity prices</a>. </p>
<p>Bond prices can fall for several reasons. It can mean that the market thinks that economic growth is going to pick up (meaning investors shift their money into riskier investments). But it can also reflect fears that inflation is on the way without much accompanying economic growth, meaning that interest rates need to go higher so that lending is still profitable. </p>
<p>In the present case, it is a <a href="https://www.ft.com/content/ff064e39-a153-4817-be6f-92d23614dfeb">bit of both</a>: the rollout of the vaccination programmes has made many observers more optimistic about the prospects of a recovery. But the rise in the price of commodities like oil, copper and coffee is more about pandemic-related supply issues than because this optimism has prompted a step-change in demand. </p>
<p>When Fed Reserve Chairman Jay Powell <a href="https://www.ft.com/content/09c527c7-801e-4a72-823b-8e4998e00de5">failed to</a> announce any immediate intervention to put a floor under the sell-off in bonds during a public appearance in early March, it <a href="https://www.ft.com/content/09c527c7-801e-4a72-823b-8e4998e00de5">appeared to</a> trigger more selling – a sign that falling bond prices have been more a reflection of fears than optimism. </p>
<p>Interestingly, in the hours since the new US$1.9 trillion (£1.4 trillion) <a href="https://www.ft.com/content/fa459d04-0693-4aa0-890a-ba187fcbdae0">US stimulus package</a> has been agreed by Congress, the bond market and stock market have both been rising. Though there have been fears that sending US$1,400 stimulus cheques to most Americans will cause a further surge in inflation, the extra consumer demand will also prop up the economy. On balance, then, this appears to have been received as a net positive by the markets. </p>
<h2>QE and perverse consequences</h2>
<p>Any attempt to explain what is happening in the markets needs to be in the context of quantitative easing (QE). Shortly after the first wave of lockdowns in early 2020, central banks stepped in to help their national economies. They announced huge new <a href="https://theconversation.com/coronavirus-five-essential-measures-to-bolster-the-global-central-bank-bazooka-133884">QE plans</a> in which they would create new money with which to buy government bonds and other financial assets. This drove up bond prices and hence kept yields (and interest rates) at very low levels to encourage as much borrowing from consumers and businesses as possible. </p>
<p>Most central banks originally began QE programmes after the 2007-09 financial crisis (besides the Bank of Japan, which began a few years earlier). This was primarily to help companies get access to capital to boost their business, in the hope that they would then hire staff, which would help to reduce unemployment rates that had been sent soaring after the crisis. </p>
<p>However, some companies took advantage of these low interest rates in another way: they borrowed cheaply and invested it in the stock market. With investors doing likewise, this has helped to drive the relentless rise in global stock markets over the past decade. It also helps to explain why these markets have been mainly climbing ever since the COVID panic sell-off of March 2020. </p>
<p><strong>S&P 500 2005-2021</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/388521/original/file-20210309-19-15pbiqp.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="S&P 500 from 2006-2021" src="https://images.theconversation.com/files/388521/original/file-20210309-19-15pbiqp.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/388521/original/file-20210309-19-15pbiqp.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=344&fit=crop&dpr=1 600w, https://images.theconversation.com/files/388521/original/file-20210309-19-15pbiqp.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=344&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/388521/original/file-20210309-19-15pbiqp.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=344&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/388521/original/file-20210309-19-15pbiqp.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=432&fit=crop&dpr=1 754w, https://images.theconversation.com/files/388521/original/file-20210309-19-15pbiqp.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=432&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/388521/original/file-20210309-19-15pbiqp.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=432&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.tradingview.com/chart/?symbol=TVC%3ASPX">Trading View</a></span>
</figcaption>
</figure>
<p>In the coming months, economies are going to reopen, but interest rates are to stay low. Fed Reserve Chairman Jay Powell <a href="https://www.ft.com/content/09c527c7-801e-4a72-823b-8e4998e00de5">may have</a> declined to announce any new interventions to date, but it is fairly clear that he will only let yields rise so far.</p>
<p>This gives investors a great opportunity to continue taking advantage of the situation. So long as the gain from your investment in stocks is greater than the interest rate you have to pay on your borrowings, you are a winner. Better still, buy stocks in a company <a href="https://www.cnbc.com/2020/06/29/the-fed-is-buying-some-of-the-biggest-companies-bonds-raising-questions-over-why.html">such as Apple</a> whose bonds central banks have been buying as part of their QE activities. Apple <a href="https://www.tradingview.com/symbols/NASDAQ-AAPL/">is still</a> trading at over double the lows of March 2020, even after the February correction. </p>
<p>But if you are not in a position to take advantage of this one-way bet, you are a loser. The central banks have already created a situation where major institutions like the biggest hedge funds and investment banks are <a href="https://www.morganstanley.com/about-us-ir/shareholder/4q2020.pdf">achieving record earnings</a> while many families are <a href="https://www.health.org.uk/news-and-comment/newsletter-features/pandemic-poverty-polling-shows-public-support-for-permanent-uplift-to-Universal-Credit">sinking into poverty</a> on the back of the pandemic. </p>
<p>The endless stimulus is in danger of creating an ever more divided society. While it is true that the latest US package (and the support measures announced in the <a href="https://theconversation.com/budget-2021-experts-react-156414">UK budget</a>) will temporarily help those struggling during the pandemic, the shot in the arm is also another way of propping up markets that seem too overvalued to fail. </p>
<p>And if they can no longer survive without central bank life-support to keep bond yields low, the question is how to prop up the markets without exacerbating inequality. It’s not clear that anyone has the answer. It might be that a shift to a much more redistributive politics to offset the widening gap between rich and poor is about the best that we can hope for.</p><img src="https://counter.theconversation.com/content/156348/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Arman Hassanniakalager 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>With the global financial system on permanent life support, even trillion-dollar stimulus packages can only do so much to restore equality.Arman Hassanniakalager, Lecturer in Finance, University of BathLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1555652021-02-19T07:31:42Z2021-02-19T07:31:42ZThe reset to lift us out of the COVID recession has to be bold: returning to where we were is nowhere near good enough<figure><img src="https://images.theconversation.com/files/385237/original/file-20210219-18-104gdg1.jpg?ixlib=rb-1.1.0&rect=95%2C269%2C3538%2C1652&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">Dmytro Larin/Shutterstock</span></span></figcaption></figure><p>Talk about returning the economy to normal after the crisis is misguided. Before the crisis, normal was nowhere near good enough.</p>
<p>Australia did indeed manage to go 28 years without a commonly-defined recession. But the expansion had three distinct stages.</p>
<p>The first, from the end of the early 1990s recession to the early 2000s, saw dramatic economic growth fuelled by dramatic productivity growth. In fact, Australia led the developed world in productivity growth — a remarkable development given that it had spent most of the twentieth century at the bottom of the developed country league table. Much of it was driven by the Hawke government’s economic reforms in the 1980s. </p>
<p>I call this first decade of the long expansion the productivity boom.</p>
<p>Australia continued to experience rapid growth in incomes for another decade, until 2013, this time driven by extraordinarily high export prices for metals and energy and the resources industries investment booms that followed. </p>
<h2>First Hawke’s boom, then China’s boom</h2>
<p>I call this second boom the China resources boom. It drew its strength from the world’s most populous country experiencing the strongest, longest and most resource-intensive economic growth of any developed country, ever. </p>
<p>During the China resources boom, as the world fell into the global financial crisis and bold fiscal and monetary stimulus in Australia and China made Australia one of only two developed countries to avoid recession.</p>
<p>Throughout these first two decades of the long boom, from 1992 to 2012, average Australian incomes, measured in international currency, rose from the bottom half of the developed country league table to the top-most tier. By 2013 Australian incomes were one-quarter higher than in the United States. </p>
<h2>Then the dog days</h2>
<p>Economic growth continued after 2013, but much more slowly, with stagnant output per person and decline in the typical household’s real wages and income. I call this third period the <a href="https://www.blackincbooks.com.au/books/dog-days">dog days</a>. In the seven years from 2013 to 2019, while the whole developed world experienced slow and grumpy times, Australia drifted to the back of the slow-moving pack. </p>
<p>Unemployment has never again fallen to anywhere near the 4% it reached on the eve of the global financial crisis. Underemployment has grown and grown. Average household disposable income per person ended the seven lean years where it began — a period of income stagnation for ordinary Australians unprecedented since (and starting to challenge in longevity) the Great Depression.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/garnauts-dog-days-16395">Garnaut's Dog Days</a>
</strong>
</em>
</p>
<hr>
<p>By 2019, average Australian incomes, again measured in international currency, were one-quarter below those of the US.</p>
<p>Many Australians are accustomed to thinking of Japan as something of an economic basket case. They might be surprised to learn that from 2013 to 2019 Australia underperformed Japan on the most important indicator of economic performance: output per person. If Japan is a basket case, on this measure Australia has been a worse one since the dog days began.</p>
<h2>We need to lift our ambition higher</h2>
<p>Returning to those dog days is deeply unattractive, but it is what is almost certain to happen if the treasurer and Reserve Bank are as good as their words.</p>
<p>Josh Frydenberg has said he will maintain an expanded budget only until unemployment “is on a clear path back to pre-crisis levels”. He defines pre-crisis levels as “<a href="https://ministers.treasury.gov.au/ministers/josh-frydenberg-2018/speeches/speech-australian-chamber-commerce-and-industry-canberra">comfortably back under six per cent</a>”.</p>
<p>That is nowhere near what Australia is capable of. </p>
<p>The truth is we won’t know what Australia is capable of until we run the economy strongly enough for long enough to see the emergence of market pressure for substantial wage increases. That might happen at an unemployment rate of 3.5%, or it might happen at an unemployment rate even lower. </p>
<h2>Our bank should buy our bonds</h2>
<p>Creating money to allow government spending to achieve early full employment comes with strings attached. So we should move as quickly as possible to full employment, while keeping debt to the lowest levels consistent with full employment on the earliest possible timetable. </p>
<p>Oddly, to not run the budget as hard as we can until we are at full employment could condemn us to endless increases in our public debt to GDP ratio because we wouldn’t be producing the GDP we were capable of. And it could damage our commitment to a liberal democratic political system.</p>
<p>The extra bonds needed to finance ramped up Commonwealth and state government spending should be bought by the Reserve Bank through <a href="https://www.rba.gov.au/education/resources/explainers/unconventional-monetary-policy.html">expanding its balance sheet</a> (creating money) rather than bought on the private market where they are likely to unhelpfully push up the value of the Australian dollar.</p>
<h2>It should not be afraid to push rates negative</h2>
<p>The Reserve Bank’s holdings of Australian government bonds are low by international standards, and they should be expanded. We should avoid running higher interest rates than other developed countries unless our economy is clearly stronger — even if that means negative short term interest rates. </p>
<p>Much contemporary economics presumes that negative or near-interest rates are impossible, or short-lived if they ever appear. The Reserve Bank treats them as anathema, to be avoided at all costs. </p>
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Read more:
<a href="https://theconversation.com/the-reserve-bank-might-yet-go-negative-149267">The Reserve Bank might yet go negative</a>
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<p>That view has been challenged by the twenty-first-century reality of very high savings and low investment on a global scale. There is no reason to expect a return to “normal” higher interest rates soon, or, with certainty, ever.</p>
<p>Low rates make the interest costs of debt small. At current interest rates, a debt of about a trillion dollars — half of annual GDP and the highest contemplated so far — would incur interest costs of about 0.5% GDP. In Japan, with public debt heading towards two times GDP and with even lower interest rates, the budget cost is currently about zero.</p>
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<a href="https://images.theconversation.com/files/385241/original/file-20210219-22-8ll2mn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/385241/original/file-20210219-22-8ll2mn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/385241/original/file-20210219-22-8ll2mn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=917&fit=crop&dpr=1 600w, https://images.theconversation.com/files/385241/original/file-20210219-22-8ll2mn.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=917&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/385241/original/file-20210219-22-8ll2mn.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=917&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/385241/original/file-20210219-22-8ll2mn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1153&fit=crop&dpr=1 754w, https://images.theconversation.com/files/385241/original/file-20210219-22-8ll2mn.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1153&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/385241/original/file-20210219-22-8ll2mn.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1153&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">Reset, by Ross Garnaut, to be released Monday.</span>
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<p>Some (most likely new) businesses will do well in an ultra-low interest rates environment. Other more-established businesses will cling to guarantees of old rates of return and withhold investment, eventually being weeded out by Darwinian processes. </p>
<p>In my new book <a href="https://www.blackincbooks.com.au/books/reset">Reset: Restoring Australia after the Pandemic Recession</a>, to be released on Monday I outline plans for a <a href="https://theconversation.com/heres-a-long-term-budget-fix-that-would-boost-investment-replace-company-tax-with-cashflow-tax-108347">new business tax system</a> that would reward businesses that invested and penalise those that lived off “economic rents” — over-high profits maintained by lobbying and barriers to competition.</p>
<p>Australians with established wealth have done extraordinarily well out of the low interest rates, rising asset values and high profit shares in the twenty-first century.</p>
<p>We are kidding ourselves if we think an extreme and growing divergence of fortune with less well off Australians is consistent with social cohesion and effective democratic government as we deal with intractable domestic and international problems.</p>
<h2>And we should pay near-everyone a basic income</h2>
<p>In my book I propose a form of basic income, I call it Australian Income Security, that would help stimulate the economy until full employment was achieved. My calculations suggest it is economically realistic.</p>
<p>Nearly all resident adult Australians would receive an unconditional fortnightly payment at the JobSeeker rate (about $15,000 per annum), indexed to the consumer price index. Extra would be paid to people who currently qualify for payments in excess of JobSeeker. The payment would attract no tax.</p>
<p>Beyond that payment, every dollar of Australians’ personal income would be taxed at 37% up to $180,000 and 45% after that.</p>
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<em>
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Read more:
<a href="https://theconversation.com/whatever-it-takes-should-now-include-a-universal-basic-income-134405">'Whatever it takes' should now include a universal basic income</a>
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<p>Receipt of the basic payment would not depend on passing a bureaucratic test of whether the recipient had put sufficient effort into the search for a job.</p>
<p>Recipients could choose to look for a job in the knowledge they would keep 63% of every dollar of income from employment. </p>
<p>It would create a much stronger incentive to find work than the high effective marginal tax imposed by the present system as benefits are withdrawn.</p>
<h2>Immigration should restart more slowly</h2>
<p>Non-Australians and Australians who had not been resident for at least half a year would be excluded, as would people with taxable income above $250,000 or with
net assets including super and a house of $2 million.</p>
<p>We will make earlier and stronger progress towards full employment and boosting living standards if we restrict our immigration program and refocus it on valuable skills.</p>
<p>Here I am not referring to the humanitarian component of our immigration program which is too small to be of much economic significance.</p>
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<em>
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Read more:
<a href="https://theconversation.com/with-our-borders-shut-this-is-the-ideal-time-to-overhaul-our-asylum-seeker-policies-146016">With our borders shut, this is the ideal time to overhaul our asylum seeker policies</a>
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<p>Immigration increases both the number of people available to work and the demand for workers. Nevertheless, economic prudence argues for holding net immigration in the decade ahead to about the level in the first stage of Australia’s three-stage recession-free expansion – the productivity boom phase.</p>
<p>Immigration was then about 0.5% of the population per year, half what it was in the dog days that preceded the COVID recession.</p>
<p>Our reset should do much better than return us to the economy we left, but there’s no need to turn our backs on the best of our past. We have faced difficult challenges before and shown we are more than capable of meeting them, often by doing more than we have done before. This is one of those times.</p><img src="https://counter.theconversation.com/content/155565/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Ross Garnaut 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>Ross Garnaut’s new book Reset argues for much bolder approach to employment, debt, interest rates and basic income than is widely envisaged.Ross Garnaut, Professorial Research Fellow in Economics, The University of MelbourneLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1548672021-02-08T15:24:13Z2021-02-08T15:24:13ZNegative interest rates may not boost UK economy – here’s what the Bank of England should try first<figure><img src="https://images.theconversation.com/files/383044/original/file-20210208-21-6zmy3t.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Life below zero. </span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/turned-cube-changed-direction-arrow-symbolizing-1807562068">Dmitriy Demidovich</a></span></figcaption></figure><p>The Bank of England <a href="https://www.theguardian.com/business/2021/feb/04/bank-england-negative-interest-rate-uk-possibility-but-far-from-certainty">has given banks</a> and building societies in the UK six months to prepare for the possible introduction of negative interest rates for the first time in its 327-year history. </p>
<p>Savers may be starting to get anxious. Negative interest rates sound like a tax on bank deposits, since they imply that instead of paying interest on deposits, banks may start charging interest instead – thereby eroding people’s savings. </p>
<p>As we shall see, it is not quite as bad as that. So how do these rates work, and should we be expecting them?</p>
<h2>What the BoE meant</h2>
<p>When the BoE announced the possibility of negative rates on February 4, from the current rate of 0.1%, it <a href="https://www.bankofengland.co.uk/-/media/boe/files/monetary-policy-summary-and-minutes/2021/february-2021.pdf">stressed that</a> “it did not wish to send any signal that it intended to set a negative bank rate at some point in the future”. Instead, it was asking the UK banks to make the necessary preparations in case these rates are required. Having consulted with the banks, six months is considered to be the necessary timeframe.</p>
<p>Negative rates are supposed to incentivise banks to lend their excess reserves to households and firms to boost economic activity, instead of parking them at the central bank. However, the BoE’s current expectation for the UK economy, taking on board <a href="https://www.bbc.co.uk/news/uk-55973847">COVID vaccination progress</a> and the <a href="https://ec.europa.eu/info/relations-united-kingdom/eu-uk-trade-and-cooperation-agreement_en">trade agreement</a> with the EU, is that economic activity will recover rapidly towards pre-COVID levels during 2021. It only expects to make use of negative interest rates if the outlook worsens: for example, if <a href="https://www.theguardian.com/world/2021/feb/08/oxford-covid-vaccine-10-effective-south-african-variant-study">vaccine-resistant variants</a> of the virus trigger a rise in infections and force another lockdown. </p>
<p>But in case negative rates become necessary, why are the banks and building societies not prepared already? To understand this, it’s necessary to jump back to the global financial crisis of 2007-09. This pushed many western economies into a deep recession with a risk of deflation taking hold. This threatened another great depression, so central banks had to act decisively. </p>
<p>They first slashed interest rates to near zero but this was not enough to stimulate the economy. Having decided negative rates were too risky at that stage, central banks introduced quantitative easing, in which they carried out large-scale purchases of financial assets, often focusing on long-term government bonds. </p>
<p>This injected liquidity into the markets, allowing financial institutions to rebalance their portfolios. It signalled that central banks were committed to maintaining low interest rates, since the increased demand for long-term bonds drives down long-term rates downwards. And it also injects “new money” into the reserves of retail banks to encourage them to lend more to businesses and consumers. </p>
<p>But quantitative easing has its limits. There is a finite number of low-risk assets that a prudent central bank can purchase. Negative interest rates have now become more likely, and have already been introduced elsewhere. </p>
<p>Sweden actually introduced them in the aftermath of the global financial crisis and then again between <a href="https://www.reuters.com/article/sweden-cenbank-rates-idUSL8N28T1LK">2015 and 2019</a>. <a href="https://www.reuters.com/article/us-danske-bank-results-idUSKBN27K0SM">Denmark</a>, <a href="https://www.reuters.com/article/us-swiss-snb-maechler-idUSKBN1XU2I5">Switzerland</a> and <a href="https://www.frbsf.org/economic-research/publications/economic-letter/2019/august/negative-interest-rates-inflation-expectations-japan/">Japan</a> are all now using negative rates, but perhaps the most important example is <a href="https://www.reuters.com/article/us-ecb-policy-rates-explainer-idUSKCN1VY1D2">the European Central Bank</a> (ECB), which sets interest rates for the 19 states in the euro area.</p>
<h2>Pros and cons</h2>
<p>Negative interest rates could mean that savers abandon bank deposits and keep their savings under the mattress instead – or in safe deposit boxes. That would cause havoc in the banking system, as banks largely rely on deposits to fund their loans to firms and households. Banks that have relied more on money markets for funding – such as Northern Rock – <a href="https://www.bbc.co.uk/news/business-41229513#:%7E:text=Northern%20Rock%20was%20an%20obvious,was%20nationalised%20in%20February%202008">haven’t always fared very well</a>.</p>
<p>To avoid these risks, negative rates have largely been limited to the reserves that commercial banks hold with the central bank. Negative rates have also been low: Japan’s rate is -0.1%, Denmark’s is -0.6% and Switzerland’s is -0.75%, while the ECB’s is -0.5%, and for bank reserves at the central bank only. Sweden’s rates were in the range of -0.1% to -0.5%. </p>
<p>That is not to say that banks might not cut their already low savings rates as they seek to shore up their profitability, but it shows that the policy has been applied cautiously. </p>
<p>However, if this implies little cost to consumers, it remains to be seen whether negative rates actually boost economic activity. For example, <a href="https://voxeu.org/article/swedish-experience-negative-central-bank-rates">the evidence from Sweden</a> points to negligible positive effects at the cost of generating significant imbalances, including increased household indebtedness and excessive rises in property prices. </p>
<h2>Forward guidance</h2>
<p>As <a href="https://theconversation.com/bank-of-england-is-considering-negative-interest-rates-it-doesnt-need-to-yet-144029">I have argued</a> before, central banks can achieve more through giving clear forward guidance about the future path of interest rates rather than taking them negative. The Bank of England occasionally uses forward guidance, but only vaguely compared to other central banks. The ECB has given much clearer signals, stating, for example, that it expects rates to remain low “for an extended period of time”. </p>
<p>This can reduce uncertainty around future borrowing costs, removing a major deterrent for new investment and job creation, and amplifying the positive benefits of low interest rates. </p>
<p>Forward guidance does require considerable preparation and background work on the part of the central bank. It is also more challenging in terms of communication, as it involves explaining future decisions as well as current ones. This can make changing course, should the need arise, difficult, risking damage to a central bank’s credibility in the process.</p>
<p>The interest rate-setting committee also has to agree over the future course of policy, which can be especially difficult when there is a lot of economic uncertainty. The BoE has the additional complication that the votes and views of individual members of the Monetary Policy Committee often strongly diverge and are published after each monthly meeting. If this meant that UK forward guidance had to be very limited or qualified, the benefits might be diluted. </p>
<p>Having said that, extraordinary times require extraordinary measures. If the banking industry can prepare in six months for a policy that has never been used in 327 years, the Bank of England can surely consider ways of further developing its forward guidance.</p><img src="https://counter.theconversation.com/content/154867/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Panicos O Demetriades is a Senior Fellow of Radix, a think tank of the radical centre. In the past he has received external funding from the Economic and Social Research Council for various research projects focusing on the role of banks in the economy and financial crises. During 2012-14, he served as a Governing Council member of the European Central Bank and Governor of the Central Bank of Cyprus.</span></em></p>UK banks have been given six months to prepare for rates going below zero.Panicos O Demetriades, Professor of Financial Economics, University of LeicesterLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1492672021-02-02T03:45:13Z2021-02-02T03:45:13ZThe Reserve Bank might yet go negative<figure><img src="https://images.theconversation.com/files/381880/original/file-20210202-13-db0s13.jpg?ixlib=rb-1.1.0&rect=310%2C227%2C3119%2C1795&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">ksb/Shutterstock</span></span></figcaption></figure><p>Few people expected the Reserve Bank to adjust its cash rate at its first meeting of the year today, and for good reason.</p>
<p>It has been saying loudly that it is “<a href="https://www.rba.gov.au/media-releases/2020/mr-20-32.html">not expecting to increase the cash rate for at least three years</a>”. Today it said the commitment extends to <a href="https://www.rba.gov.au/media-releases/2020/mr-20-28.html">2024</a>.</p>
<p>But it isn’t a commitment not to <em>cut</em> the cash rate.</p>
<p>A further <em>cut</em> in the cash rate to take it below its present all-time low of 0.10% would turn the cash rate negative.</p>
<p>The cash rate is that rate that banks pay <a href="https://www.rba.gov.au/glossary/?search=Cash+Rate">to borrow money from each other</a>. </p>
<p>It has always been positive, at times very positive.</p>
<p>Ten years ago it was <a href="https://www.rba.gov.au/statistics/cash-rate/">4.75%</a>. Then, as now, it was used to help set every other rate.</p>
<p>But there’s no reason why it couldn’t be negative. Borrowing (accepting deposits) <a href="https://theconversation.com/negative-rates-explained-how-money-for-less-than-nothing-is-helping-out-the-budget-152082">entails costs</a>. If the banks offered funds are offered more than they need, they’ll charge for accepting them.</p>
<h2>Some rates are already negative</h2>
<p>It’s already happened in the bond market. In several bond auctions, lenders to Australian government have agreed to pay <a href="https://theconversation.com/sure-interest-rates-are-negative-but-so-are-some-prices-and-when-you-look-around-theyre-everywhere-152081">for having the government accept their money</a>.</p>
<p>Overseas, <a href="http://www.worldgovernmentbonds.com/">bond rates</a> in Germany, Switzerland, Netherlands, Slovakia, Denmark, Austria, Finland, Belgium, France, Ireland, Slovenia and Lithuania are negative. In Germany it means that someone lending the German government 105 euros agrees to get back only 100 euros when the loan expires ten years later.</p>
<p>In at least three countries, <a href="https://www.bis.org/statistics/cbpol.htm?m=6%7C382%7C679">Japan, Denmark and Switzerland</a> cash rates are also negative, at rates of -0.10%, -0.60% and -0.75%. </p>
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<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/negative-rates-explained-how-money-for-less-than-nothing-is-helping-out-the-budget-152082">Negative rates explained: how money for (less than) nothing is helping out the budget</a>
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<p>In two other countries, the <a href="https://www.bankofengland.co.uk/-/media/boe/files/monetary-policy-summary-and-minutes/2020/september-2020.pdf">Bank of England</a> and the <a href="https://www.rbnz.govt.nz/-/media/ReserveBank/Files/Monetary%20policy/ump/Preparations-and-readiness-for-negative-interest-rates.pdf?revision=992f1535-e782-44e9-a7a3-bfaa9224570e&la=en">Reserve Bank of New Zealand</a> are talking with banks about how to make negative cash rates work. </p>
<p>Calculations I carried out with colleague <a href="https://onlinelibrary.wiley.com/doi/full/10.1111/1467-8462.12406">Timothy Anderson</a> suggest that if Australia’s Reserve Bank acted in accordance with its previous behaviour, it would have turned Australia’s cash rate briefly negative in the second half of last year.</p>
<h2>There’s a case for negative cash rate here</h2>
<p>Our model, that accurately describes previous Reserve Bank behaviour, is that the bank has a view about the “neutral” cash rate, one that will leave the economy neither “too hot” (too much inflation) nor “too cold” (too much unemployment). If inflation remains too low (and/or unemployment too high) at the neutral rate it moves the cash rate below neutral until inflation climbs back up.</p>
<p>In August 2020 when the Bank was <a href="https://www.rba.gov.au/publications/smp/2020/aug/pdf/06-economic-outlook.pdf">forecasting a dire outlook</a> with unemployment peaking at 10% and inflation well below target our model suggests that if the bank was following previous practice it would have cut the cash rate to around -0.25%.</p>
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<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/sure-interest-rates-are-negative-but-so-are-some-prices-and-when-you-look-around-theyre-everywhere-152081">Sure, interest rates are negative, but so are some prices, and when you look around, they're everywhere</a>
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<p>By November 2020 when the bank’s <a href="https://www.rba.gov.au/publications/smp/2020/nov/pdf/06-economic-outlook.pdf">forecasts</a> were more positive, our model suggests a positive, but still extraordinarily low cash rate, of about the 0.10% <a href="https://www.rba.gov.au/media-releases/2020/mr-20-28.html">it adopted.</a></p>
<p>Australia’s Reserve Bank has been remarkably reluctant to take rates negative, seeing a cut into negative territory as fundamentally different to a cut that leaves rates positive.</p>
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<span class="caption">Reserve Bank Governor Lowe.</span>
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<p>Governor Philip Lowe has repeatedly said that negative rates are “<a href="https://www.rba.gov.au/publications/smp/2020/nov/pdf/00-overview.pdf">extraordinarily unlikely</a>”.</p>
<p>But he has conceded he would have to consider them if the <a href="https://webcast.boardroom.media/player/reserve-bank-of-australia/20201103/NaN5fa0d42499dc7700190d8473">world’s other important central banks went negative</a>, a contingency several of them are preparing for.</p>
<p>Economic studies suggest that the neutral rate has been heading downwards for <a href="https://www.rba.gov.au/publications/bulletin/2017/sep/pdf/bu-0917-2-the-neutral-interest-rate.pdf">decades</a> and possibly <a href="https://www.bankofengland.co.uk/working-paper/2020/eight-centuries-of-global-real-interest-rates-r-g-and-the-suprasecular-decline-1311-2018">centuries</a>. If the trend continues, negative rates will eventually become widespread. </p>
<p>To not match negative rates elsewhere would be to invite an influx of “hot money” chasing higher rates in Australia than were available elsewhere, pushing the Australian dollar uncomfortably high.</p>
<p>For now, the Reserve Bank has adopted a suite of other <a href="https://theconversation.com/5-ways-the-reserve-bank-is-going-to-bat-for-australia-like-never-before-149311">unconventional measures</a>, such as <a href="https://www.rba.gov.au/publications/bulletin/2020/dec/pdf/the-term-funding-facility.pdf">lending cheaply to banks</a> and buying government bonds, that it believes will have <a href="https://www.rba.gov.au/publications/bulletin/2020/sep/pdf/the-economic-effects-of-low-interest-rates-and-unconventional-monetary-policy.pdf">much the same effects</a> as taking the cash rate negative.</p>
<p>Today it extended announced a decision to buy an additional A$100 billion of bonds when the current bond purchase program expires in mid April. </p>
<p>Lowe will explain more in a televised address to the <a href="https://www.npc.org.au/">National Press Club</a> on Wednesday.</p>
<p>Should things worsen here or overseas he might have to go further and overcome his reluctance to push the cash rate negative.</p>
<h2>We don’t quite know what would happen</h2>
<p>How a negative cash rate would play out depends on how the banks respond.</p>
<p>There are three possibilities.</p>
<p>First, the banks could adjust neither their deposit nor lending rates, meaning the negative cash rate had little effect.</p>
<p>Second, the banks adjust down both their deposit and loan interest rates, but this would mean charging depositors for placing funds with them, something banks haven’t done in other countries that have zero rates for fear of losing customers.</p>
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<a href="https://theconversation.com/negative-interest-rates-could-be-coming-what-would-this-mean-for-borrowers-and-savers-149898">Negative interest rates could be coming. What would this mean for borrowers and savers?</a>
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<p>Third, banks could lower lending interest rates only. This might avoid unpopularity among customers but would erode interest margins. Over time banks might become less keen to lend.</p>
<p>It’s not clear what bank customers would do. In 2015 a survey conducted for ING Bank asked what savers would do if the deposit interest rate fell to minus 0.5%.</p>
<p>Only 10% said they would spend more. 14% said that they would <a href="https://voxeu.org/article/negative-rates-negative-reactions">save even more</a>. 42% said they would switch some or most of their savings to somewhere like the stock market. 21% would move it to “a safe place”.</p><img src="https://counter.theconversation.com/content/149267/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>John Hawkins formerly worked for the Reserve Bank of Australia and the Bank for International Settlements.</span></em></p>If the Reserve Bank had acted as it usually does, the cash rate would have dipped briefly negative in August.John Hawkins, Senior Lecturer, Canberra School of Politics, Economics and Society, University of CanberraLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1495812020-11-09T13:44:58Z2020-11-09T13:44:58ZWill the Bank of England’s reliance on quantitative easing work for the UK economy?<p>It was the Bank of Japan which first embarked on the experiment known as quantitative easing, or QE, in order to try and <a href="https://www.frbsf.org/economic-research/publications/economic-letter/2001/november/quantitative-easing-by-the-bank-of-japan/">stimulate the Japanese economy</a> out of its period of very low growth known as the “lost decade” between 1991 and 2001. Since the global financial crisis and recession of 2007-2009, quantitative easing has been a mainstay of western governments’ monetary policies aimed at stabilising the economy. </p>
<p>However, central banks have spent trillions on QE since in the years since – <a href="https://www.bankofengland.co.uk/monetary-policy/quantitative-easing">£895 billion in the UK alone</a> – and as the Bank of England <a href="https://www.theguardian.com/business/2020/nov/05/bank-of-england-launches-new-150bn-stimulus-package">launches a new £150 billion stimulus package</a> there are questions as to whether QE can provide the economic stability governments and markets are hoping for in the face of economic paralysis caused by the pandemic.</p>
<h2>QE in a nutshell</h2>
<p>With quantitative easing, central banks create money to buy government-issued bonds from banks and other investors, which provides them with cash to lend or invest in the economy. This prompts increased demand for government bonds, which in turn raises their price and causes the returns on the bonds to fall. </p>
<p>Governments issue bonds of different duration, the length of time before the government repays the value of the bond back to the purchaser, which range from a few years to many decades. Each bond of different duration is worth a different amount of money in repayments to the purchaser, known as a yield. Plotting yields against the duration of the bond generates what is called a yield curve. </p>
<p>Under normal economic conditions we expect yield curves to increase as duration increases – a rising yield curve. Quantitative easing has two effects on yield curves: it lowers the curve, so that yields are lower for bonds of all durations, and it forces the yield on longer duration bonds to fall into line with those of shorter duration, flattening the yield curve. Faced with these lowered returns from investing in bonds, banks and investors are more inclined to invest in the real economy where better returns can be found, providing an economic boost.</p>
<h2>Has QE been effective, and can it be effective now?</h2>
<p>Looking at the 12 years of quantitative easing in western economies since the financial crisis, and 20 years in the case of Japan, the impact of QE has been mixed. For Japan specifically there is some evidence that QE reduced the long-term interest rate, <a href="https://www.sciencedirect.com/science/article/abs/pii/S1062940818305448">causing the Japanese Yen to depreciate</a>. For other advanced economies, one of the main motivations was to avoid a surge in unemployment, and in this regard QE succeeded in both <a href="https://www.theguardian.com/business/2019/mar/08/the-verdict-on-10-years-of-quantitative-easing">the UK</a> and <a href="https://www.theguardian.com/business/economics-blog/2014/oct/29/the-fed-to-call-time-on-qe-in-the-us">the US</a> – at least, until the pandemic. </p>
<p>When QE began it was seen as a temporary, emergency measure. Yet more than a decade later it continues, and grows. One side effect of QE is that it has made the rich richer: borrowers with large mortgages benefit from <a href="https://www.bankofengland.co.uk/-/media/boe/files/speech/2009/money-banks-and-quantitative-easing.pdf">lower interest rates</a>. The excess cash now washing around the economy has caused <a href="https://www.ft.com/content/bc83fda6-3702-11ea-a6d3-9a26f8c3cba4">stock market bubbles in financial markets</a>.</p>
<p>Coordinated action from the Treasury and the Bank of England indicates that they believe the economy to be in serious trouble. The furlough scheme has been <a href="https://www.gov.uk/government/news/government-extends-furlough-to-march-and-increases-self-employed-support">extended to end of March 2021</a>, which may indicate that the government is not convinced the UK will emerge from lockdown in December, and, as <a href="https://www.bbc.co.uk/news/uk-54767118">comments have hinted</a>, lockdown may extend into the new year. This will lead to a <a href="http://www.oecd.org/economic-outlook/june-2020">double-digit decline in the UK economy</a> for 2020.</p>
<p>A new round of QE in Britain must be seen in this context, perhaps motivated by additional factors such as the very low <a href="https://www.ons.gov.uk/economy/inflationandpriceindices">inflation rate of 0.7%</a> (as measured by the consumer price index). Given such a low rate it’s possible that the coming period of depressed economic activity may lead to negative inflation rates – otherwise known as deflation, as briefly occurred during 2015-2016. The bank may see QE as a precautionary measure to avoid deflation, which <a href="https://www.cbsnews.com/news/explainer-why-is-deflation-so-harmful/">causes problems</a> including a decline in consumer spending and an effective rise in interest rates.</p>
<h2>The next 12 months</h2>
<p>But what of next spring, in March 2021 when the furlough scheme ends? The Bank of England and the Treasury will be busy: the bank may inject more money into the economy yet more rounds of QE, coupled with lowering the bank interest rate further – from its <a href="https://www.theguardian.com/business/2020/mar/19/bank-of-england-cuts-interest-rates-to-all-time-low-of-01">current all-time low of 0.1%</a> perhaps even into <a href="https://www.theguardian.com/business/2020/oct/20/bank-of-england-negative-interest-rates-gertjan-vlieghe-covid">negative territory</a>. This will force commercial banks to invest their money in the real economy, as the only means to generate a return. Looked at in this context, the current QE can be interpreted as preparing the ground for negative interest rates, with the expectation that inflation will remain low for the foreseeable future. </p>
<p>All these factors will make it even cheaper for the Treasury to borrow by issuing bonds with very low yields. Heading towards a post-pandemic world, we should expect more government borrowing in order to support the economy.</p>
<p>We cannot know for sure whether this arrangement of the Treasury issuing bonds to investors and the Bank of England buying them back will be successful until counting the costs, well after the pandemic has ended. That said, if the UK can avoid a substantial rise in unemployment after the furlough scheme ends, or if a short spike quickly recovers by the end of 2021 alongside wider economic growth, then we will be through the worst and may judge the current strategy to have been a success.</p><img src="https://counter.theconversation.com/content/149581/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Ghulam Sorwar 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>QE has been used for more than a decade since the global financial crisis, but the impact has not been as governments had hoped.Ghulam Sorwar, Professor of Finance, Keele UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1490272020-10-28T22:25:29Z2020-10-28T22:25:29ZCapitalism and the coronavirus crisis: the coming transformation(s)<p>The world economy is currently experiencing its severest contraction since the Great Depression of the 1930s. Unlike the Great Depression and the global financial crisis (GFC) of 2008-2009, this crisis cannot be directly attributed to the dysfunctional workings of capitalism. But even if it is not a crisis <em>of</em> capitalism, it is a crisis <em>for</em> capitalism. Chronic ills of contemporary capitalism – notably rising levels of socio-economic inequality and debt of all kinds – are being exacerbated and intensify the danger of further political polarization and fresh financial instability.</p>
<p>Capitalism will nonetheless survive this crisis as it has done previous ones. The fundamental structures of capitalism typically don’t change fast. But they can change and they do, especially at critical historical junctures, such as in response to wars and economic crises – or, potentially, pandemics.</p>
<h2>State interventionism</h2>
<p>Compared with recent decades, in post-Covid-19 capitalism the state will emerge as a more dominant actor. Even more than in the years after the GFC, central banks have been resorting to increasingly unorthodox, expansionary monetary policies to stave off economic collapse. To the same end governments have begun and will continue to pursue expansionary fiscal policies and run up ever-higher budget deficits. Austerity policies have suddenly become unfashionable. Sectoral or “industrial” policies have regained favour, with governments everywhere intervening to assist firms in those sectors, such as air transport or tourism, which the crisis otherwise would destroy. Policies to “re-localize” production of critical goods in crises, such as medical equipment and supplies, are suddenly in vogue, whereas state aid policies aimed at preventing distortions of competition are not. The intellectual champions of the free market have fallen silent.</p>
<p>Regardless of how fast the world economy recovers from the crisis, longer-term factors – possible new pandemics and pressures to mitigate or adapt to climate change or, in the “old” advanced capitalist economies, to create a more level playing field against firms aided by the Chinese state – will keep the pressure on governments to maintain or strengthen existing levels of state intervention.</p>
<p>To say that the state will be a more dominant actor in post-Covid-19 capitalism is not to say, however, that previously divergent capitalisms are converging on a uniform “statist” model. State economic intervention can manifest highly divergent forms. Here the 1930s may offer some salient parallels. Higher levels of state intervention characterized countries that moved politically to the left as well as to the (far) right. Numerous countries, such as in Sweden and New Zealand, where Labour and Social Democratic parties came to power in this period, or the US under President Roosevelt, embarked on Keynesian deficit-spending policies that reduced mass unemployment, strengthened organized labour and expanded collective social welfare provision.</p>
<p>At the other end of the politico-ideological spectrum, fascist or Nazi regimes, such as Mussolini’s Italy and Hitler’s Germany, also engaged in large-scale deficit-spending, while destroying liberal democracy, smashing the labour movement, implementing protectionist economic policies, and mobilizing their societies for war.</p>
<h2>Growing polarization</h2>
<p>In the wake of the coronavirus crisis, the democratic-capitalist world may well undergo a process of political polarization comparable to what occurred in the 1930s. Depending on the shifting distribution of domestic political power, countries may tend toward one or the other of two scenarios. In one, which might be labelled “yellow capitalism” (combining the colours Social Democratic red and green), state intervention would aim to redistribute income and wealth on a greater scale than is the case in most capitalist democracies today and to take more sweeping measures to combat global warming.</p>
<p>‘Yellow capitalism" would be fundamentally internationalist, recognizing the fact that the most severe challenges facing humankind are global and can be managed effectively only through comprehensive international cooperation. But it would create scope for governments to protect their economies for specific purposes, such as to combat climate change, for example through carbon tariffs. In this scenario, private business would be much more tightly constrained by state regulation than at the peak of neo-liberal capitalism after the Cold War.</p>
<p>The core support for this incarnation of capitalism, which synthesizes the aspirations of the “old” labour movement and “new” social, especially environmental, movements, would be found in the (especially younger) professional middle classes in the big cities and towns and the unionized working class. Even centrist political parties could support this kind of political agenda.</p>
<p>The other scenario (combining the colour black for nationalism and brown for right-wing populism) might be termed “light-black capitalism”. Like “yellow capitalism”, it would also be highly interventionist, but would be fiscally regressive rather than redistributive, as has been the thrust of President Trump’s tax policy in the US. Climate change would be ignored in favour of maximizing (quantitative) economic growth. Domestic business would be increasingly protected from international competition, while comprehensive immigration controls would offer the (ethnically defined) “people” some protection from the competition of “foreign” workers. The core support for “light-black capitalism” would be in domestic-market-oriented business, among residents of small towns, villages and the countryside as well as in declining industrial regions, among “value conservatives” afraid that changes in dominant social values are destroying traditional norms and life-styles, and among “status anxious” workers hostile to immigration.</p>
<h2>Rising risks</h2>
<p>Which of these two incarnations of a state-interventionist capitalism – “yellow” or “light-black” – becomes the predominant form in the post-coronavirus era will be determined by the outcomes of political struggle and conflict in mostly national political arenas. The only thing that is certain is that, for the time being at least, market-friendly incarnations of capitalism will wither.</p>
<p>So far, in the coronavirus crisis, citizens in most countries have rallied to their governments in a spirit of national unity akin to what has occasionally happened historically at the outbreak of wars. However, we are currently still passing through the first stage – the <em>public-health</em> phase – of the coronavirus crisis. Expansionary monetary and fiscal policies and the subsidization – on a massive scale – of short-time work have enabled most governments to postpone the arrival of the second, the <em>economic and financial</em>, phase of the crisis. But unless the recovery of the world economy is very rapid, this next phase will materialize. It will be all the more destructive now that a second wave of the coronavirus is upon is, requiring new lockdown measures that will exacerbate the economic problems caused by those taken earlier this year.</p>
<p>This phase of the crisis will likely witness greater, perhaps much greater, social and political upheaval than the first. Regardless of how well or badly some national-populist governments have hitherto managed the crisis so far, the growing socio-economic dislocation and insecurity that will increasingly characterize this second phase of the crisis could give movements based on this kind of ideology a powerful new impetus.</p>
<p>An upsurge of “light-black capitalism” would likely plunge the world economy into an even deeper recession. Even more ominously, it would also increase the probability of large-scale military conflict. As the American economist Otto Mallery wrote during the Second World War: “When goods don’t cross borders, soldiers will”. In this regard too, the events and trends of the 1930s still provide us today with lessons that we ignore at our peril.</p><img src="https://counter.theconversation.com/content/149027/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Douglas Webber ne travaille pas, ne conseille pas, ne possède pas de parts, ne reçoit pas de fonds d'une organisation qui pourrait tirer profit de cet article, et n'a déclaré aucune autre affiliation que son organisme de recherche.</span></em></p>The global economy is currently experiencing its severest contraction since the 1930s. While capitalism will survive, its fundamental structure can change at critical historical junctures.Douglas Webber, Professor of Political Science, INSEADLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1485142020-10-22T00:16:30Z2020-10-22T00:16:30ZExplainer: why the government can’t simply cancel its pandemic debt by printing more money<figure><img src="https://images.theconversation.com/files/364862/original/file-20201021-13-1xahq8c.jpg?ixlib=rb-1.1.0&rect=26%2C8%2C5964%2C3359&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">www.shutterstock.com</span></span></figcaption></figure><p>With the government <a href="https://www.stuff.co.nz/national/health/coronavirus/120725802/coronavirus-government-doubles-borrowing-forecast-as-economy-worsens">borrowing heavily</a> to fund its pandemic response and recovery, it has been <a href="https://www.nzherald.co.nz/business/could-nz-write-off-all-its-debt-what-business-leaders-think/UPBQBYLGPOP3IQGN7G5Z5XFAE4/">suggested</a> it could simply cancel its debt by printing more money. That sounds like an attractive idea, but it is one that would have seriously adverse consequences. </p>
<p>Derived from “<a href="https://www.businessinsider.com.au/modern-monetary-theory-mmt-explained-aoc-2019-3?r=US&IR=T">modern monetary theory</a>” (MMT), the suggestion is that expansionary monetary policy (i.e. money creation by the central bank) be used to finance government spending. </p>
<p>According to proponents of MMT, a country that issues its own currency can never run out and can never become insolvent in its own currency. It can make all payments as they come due. Therefore, there is no risk of defaulting on its debt.</p>
<p>This is a flawed idea based on economic misconceptions. It has been opposed by economists, liberal and conservative, including Nobel laureate and New York Times columnist <a href="https://www.nytimes.com/2019/02/25/opinion/running-on-mmt-wonkish.html">Paul Krugman</a> and Harvard University’s <a href="https://scholar.harvard.edu/files/mankiw/files/skeptics_guide_to_modern_monetary_theory.pdf">Greg Mankiw</a>. </p>
<p>So, what does happen when the government wants to spend more than it raises in tax revenue? It needs to borrow money (known as deficit financing), and so instructs the Treasury to issue debt. </p>
<p>There are three major types of debt: <a href="https://debtmanagement.treasury.govt.nz/government-securities/treasury-bills">treasury bills, treasury notes and treasury bonds.</a>. Treasury bills have the shortest maturity (less than a year) while treasury bonds have maturities of ten years or more. They all must be paid back in the future. </p>
<p>The debt is typically held by banks, institutional investors and managed funds (such as Kiwisaver accounts). Because the government is not expected to default on the loans, the debt is considered to be secure. So, these bonds can typically be issued at lower interest rates than bonds from other financial entities.</p>
<h2>Where government debt goes</h2>
<p>When the Reserve Bank of New Zealand (RBNZ) engages in “<a href="https://www.anz.co.nz/content/dam/anzconz/documents/economics-and-market-research/2020/ANZ-RBNZ-QE-FAQ-20200507.pdf">quantitative easing</a>” it essentially buys up these government issued bonds. To do this, it prints currency to pay for the bonds and this currency goes into circulation, increasing the money supply.</p>
<p>Quantitative easing floods the system with liquidity — the amount of money readily available for investment and spending. In turn, this should put downward pressure on interest rates because money is cheaper to borrow when there is more of it.</p>
<p>The RBNZ can also lower the official cash rate (<a href="https://www.rbnz.govt.nz/monetary-policy/official-cash-rate-decisions">OCR</a>) to push retail interest rates (on mortgages and savings deposits) down. The aim in both cases is to make borrowing cheaper in the hope that businesses will borrow money to invest, in turn creating more jobs.</p>
<p>If the RBNZ is buying government bonds from the banks and investors who had bought them earlier, it follows that the creditors have been paid off. So why can’t the government simply write off this debt?</p>
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<a href="https://theconversation.com/with-a-mandate-to-govern-new-zealand-alone-labour-must-now-decide-what-it-really-stands-for-144490">With a mandate to govern New Zealand alone, Labour must now decide what it really stands for</a>
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<p>Firstly, this takes away the RBNZ’s ability to act as an independent entity, which in itself is problematic. But even so, the debt does not disappear, it just takes the form of that additional amount of money floating around the economy. </p>
<p>At some point this extra money will end up being deposited in commercial banks and be held as reserves which earn interest from the RBNZ. </p>
<p>The currency in circulation is also legal tender backed by the authority of the government. If no one else wants to accept it, holders of this money should be able to sell it back to the RBNZ for something of value in return (US dollars, say).</p>
<p>One way or another, sooner or later the debt will have to be honoured.</p>
<h2>The risk of inflation</h2>
<p>In the meantime, if lower interest rates do not lead to business expansion and higher production (and there are good reasons to suppose they may not) then the net result is a larger amount of money circulating in the economy with no new production happening. </p>
<p>This will eventually set off inflationary pressures, which make savers worse off and provide a disincentive for saving. But saving by households is fundamental to making funds available for businesses to borrow.</p>
<p>In the absence of increased production this extra money may also make its way to non-productive financial assets such as equity and houses, setting off <a href="https://www.researchgate.net/publication/316804372_Quantitative_easing_and_asset_bubbles">speculative bubbles</a> in those markets. </p>
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<a href="https://theconversation.com/covid-19-is-predicted-to-make-child-poverty-worse-should-nzs-next-government-make-temporary-safety-nets-permanent-147177">COVID-19 is predicted to make child poverty worse. Should NZ's next government make temporary safety nets permanent?</a>
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<p>Why might businesses not expand, even with lower interest rates? In deep recessions it is not the lack of credit that holds them back, it is that they cannot sell their goods at prevailing prices. This reduces demand for labour, further reducing demand for goods because more customers are unemployed.</p>
<p>It becomes a vicious cycle of insufficient demand, where the key issue is not credit or liquidity but rather a <a href="https://researchspace.auckland.ac.nz/handle/2292/13330">crisis of confidence</a>. Monetary policy loses its teeth at this point, leaving fiscal policy (via deficit financing or tax cuts) as the only option.</p>
<h2>It’s all about trust</h2>
<p>However, government borrowing is a long-term game. The entire system, whether deficit financing or printing money, is based on trust — that the government will honour its debt.</p>
<p>Simply put, no government could satisfy all its creditors if they wanted their money back at the same time. But as long as the government keeps making the interest payments on the loans, or at least has the capacity to pay back some of those creditors (sometimes by borrowing even more), the economy remains stable. The juggler’s balls stay in the air.</p>
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Read more:
<a href="https://theconversation.com/nz-election-2020-survey-shows-voters-are-divided-on-climate-policy-and-urgency-of-action-146569">NZ election 2020: survey shows voters are divided on climate policy and urgency of action</a>
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<p>If for some reason trust in a government goes, watch the balls come crashing down. Any hint of default or not honouring debt obligations will lead to long-term damage to a government’s reputation and its future ability to borrow. No one will want to hold the government’s debt in the form of government bonds.</p>
<p>When that happens, we see <a href="https://www.investopedia.com/terms/c/capitalflight.asp">capital flight</a> — money flows out of the country as people seek a return elsewhere. The value of the currency goes through the floor, with catastrophic effects on the economy, such as occurred during the <a href="https://en.wikipedia.org/wiki/1997_Asian_financial_crisis">Asian financial crisis</a> in 1997. </p>
<p>The economic crisis New Zealand is facing is real and deep. Attempting to cancel debt would only reduce trust in the government and risk making the crisis worse.</p><img src="https://counter.theconversation.com/content/148514/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Ananish Chaudhuri has received funding from the Royal Society of New Zealand Marsden Fund. </span></em></p>Massive borrowing to fund NZ’s economic recovery due to COVID-19 cannot be written off without the risk of worsening the crisis it was designed to meet.Ananish Chaudhuri, Professor of Behavioural and Experimental Economics, University of Auckland, Waipapa Taumata RauLicensed as Creative Commons – attribution, no derivatives.