Degrees of muddle

Robin Harding of FT writes that interest rates in the West may not be too low because the state of their economies supports a pessimistic hypothesis – that they are in a secular stagnation or have experienced a permanent fall in potential growth rates. To me, both are more or less the same. But, Mr. Harding says that the latter could be because the relationship between interest rates and output might have changed due to ‘mercantilist policies of China’. I have to scratch my head. But, I refrain from doing so because the hairline is thinning. Secular stagnation arises because all low-hanging fruits of economic growth have been plucked. That is the same as saying that potential growth is permanently low. It is not caused by temporary factors. His muddle does not stop there.

He then cautions against central banks acting against high asset prices in such a scenario for it would worsen the economic situation. Wait a minute. He seems to think that we know how to distinguish between ‘high asset prices’ and a ‘bubble’. Second, he does not seem to consider the risk that high asset prices – which are already decoupled from the poor economic backdrop – if continued to be supported by low interest rates, could actually crash one day and further cementing or driving the last nail into the economic coffins in the West. Strange piece.

He need not worry, though. A worse piece has been written by Wolfgang Muenchau. He seems to think that the answer to Eurozone low inflation is ECB asset purchases. Yes, of course. Quite. America and Britain have succeeded remarkably well with their quantitative easing and that Europe has missed out on a growth resurgence driven by investment spending and productivity growth. What non-sense! Andrew Smithers’ wonderful blog post on the state of the UK economy has an eye-popping chart on the ratio of Fixed Investment as a percentage of GDP in the UK. It has continued to drop, despite (or, because of?) low interest rates. All that the Fed and the BoE have done is to boost asset prices and create yet another round of decoupling of asset prices from economic fundamentals as was the case before the crisis. Mr. Muenchau laments that the European Central Bank (ECB) has not followed in their footsteps.

They all suffer from the same malady – they think that economies are like their pets. They can be cajoled, warned and coerced into doing their bidding, sometimes with low rates, sometimes with high rates and sometimes with printing money and sometimes with cheap currencies. What if you were powerless and things were happening in spite of you and not because of your efforts?

Economic growth – especially of the structural or long-term variety – is really one such thing. Monetary policy can, at best, influence growth for a few quarters. But, what we are facing now is a different beast. Our best growth days are behind us. In fact, somewhat provocatively but with ample justification, one could say that a substantial part of global economic growth in the Common Era had occurred in the twenty five years ending 2007. Think about it. Something has to give. It was too unsustainable on many fronts to continue. Trying to revive it or resurrect that is madness. I have written about it in my column in MINT today.

But, incredibly, western monetary policy is trying precisely that. The outcome could be much worse than just a secular economic stagnation. Chiding the ECB for not joining them yet is worse than ECB joining them. It may well happen soon, of course.


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