As the Reserve Bank’s cash rate halved through 2019, Australia officially entered the ultra-low rate void that most of the developed world experienced in the aftermath of the global financial crisis and in which much of the developed world remains trapped today. The challenge for policymakers is to find an exit path.
There may not be one. The one economy that appeared to be on the path towards more normal rate and growth settings, the US, was forced to backtrack at the start of 2019, when the Federal Reserve Board’s cautious rate hikes and the shrinking of a balance sheet swollen by its bond and mortgage purchases during the crisis years sparked an implosion in financial markets.
The Fed retreated and cut its version of the cash rate three times in 2019 and halted the contraction of its balance sheet. Europe and Japan remain stuck in a negative-rate, anaemic-growth environment and even China’s rate of expansion has dwindled, as the trade war with the US hampered its economy.
A decade after the nadir of the crisis appeared to pass in March 2019, policymakers (dominated by the major central banks) are at a loss to explain why the unprecedented actions they have taken have produced such meagre returns or to outline a path towards growth settings that might be regarded as more normal than those now being experienced.
The biggest question of the post-crisis era is whether the low-rate, low-growth environment we are now experiencing is, in fact, the “new normal”.
Was it a coincidence that the developed world seemed to hit a wall around the time of the crisis, or are the current conditions the result of the crisis and the way central banks responded to it? Could it be a combination of both?
The latter is probably the better explanation.
There are good reasons to believe the developed world economies would have slowed at about this time regardless of whether there was a financial crisis or not.
The first generation of Baby Boomers, those with the wealth and the greatest propensity to consume, were just starting to enter the retirement phase when the crisis hit. Most of the remaining Boomers, generally defined as those born between 1946 and 1964, will be out of the workforce by the middle of this decade. Over the past 10 years, this generation has have shifted from being consumers to savers.
At the same time, there has been an accelerating change in the nature of developed world economies as technology reshaped industries.
Companies like Amazon, Google, Facebook and Apple aren’t capital-intensive or people-intensive in the way that 20th century industries were. Globalisation and, until the trade war, the inexorable rise of China and its exporting of deflation via the lowered cost of manufactured products, is another strand to the explanation.
Savings rates in the developed world have increased, while the demand for capital for productive investment has decreased.
Economists and central bankers talk about a “neutral” interest rate – the rate which balances savings and investment at a level that delivers full employment with stable inflation.
The historical demographic and technological shifts that have been occurring over the past decade may reflect a structural change in the neutral rate, one that permanently sets it at levels never previously experienced.
The contribution of the central bankers to these outcomes may have been to inject too much ultra-cheap liquidity into the financial system and leave too much of it sloshing around for too long.
They have incentivised, as they sought to, risk taking but the wrong risks have been taken. Business investment has been weak around the world; instead the low rates and easy access to credit have fuelled sharemarket and housing booms and a leveraging of the global economy across government, business and households.
The world is drowning in debt – debt-to-GDP levels have risen dramatically since the crisis – which by itself makes it difficult, if not impossible, for central banks to try to normalise their monetary policy settings without risking another financial crisis.
It is conceivable that, in responding to the financial crisis, central bankers have helped exaggerate and accelerate the structural trends already underway.
There is no obvious path towards more conventional settings or more buoyant growth. Developed world populations will continue to age and capital-light technologies will continue to displace the more capital-intensive activity (and jobs) of the past.
Savers will continue to accept higher risks for positive returns, exacerbating the sensitivity and vulnerability of financial markets to monetary policies and continuing to act as a deterrent to efforts by the central banks to avoid the traps of low growth and excessive debt.
If there is an exit from the current circumstances, policymakers are yet to find it.
They can’t explain why the US, for instance, has been able to generate moderate but respectable economic growth and record low unemployment levels but isn’t generating inflation and can’t lift rates or return the Fed’s balance sheet to less stimulatory levels without triggering a meltdown in financial markets and a recession in the economy.
A decade after the world seemed to be emerging from the worst of the financial crisis, there has been no return to normal settings. Perhaps this is because what’s normal today and into the future is quite different to what it was before the crisis. The Boomers’ legacy may be a much less buoyant economic era than the one they enjoyed.
Source: Thanks smh.com