The former Chairman of the Federal Reserve Board is now blogging at Brookings Institution. He has begun by addressing the question of low rates of interest and the question of secular stagnation. These two questions have been addressed in this blog several times over in the last six years that this blog has been around.
If low rate of interest (policy interest rate) reflect low equilibrium rate of interest which, in turn, reflects low rates of return to capital which, in turn, reflects low economic growth rate, the question is whether keeping policy rates low solves the problem of the low equilibrium economic activity or exacerbates it.
Many reservations on the role of low interest rates in helping to lift the equilibrium rate of economic activity can be expressed:
(1) Interest rates are a tool to boost cyclical demand. They may not and do not help in lifting structural economic growth. Sometimes, there are problems and sometimes, there are problems that cannot be solved. Humility and modesty would help and hasten the search for real solutions.
(2) Low interest rates foster financial and asset price bubbles and when they burst, as they inevitably do, they take down equilibrium rate of growth, depending on the length and the size of the bubble that preceded the burst and the leverage (debt) that inflated the bubble. The wrong allocation of capital made during the bubble may be irrecoverable and, second, that non-recovery might mean less capital for future investments. Therefore, low real rates of interest might ultimately push the equilibrium economic activity lower rather than lift it higher.
(3) Further, the deadweight of failed investments might take years to clear up, if they are cleared up at all, in the first place. Political economy factors keep zombie enterprises alive. Low interest rates facilitate keeping them alive. To that extent, low interest rates have been anti-capitalism.
(4) As for low rates boosting investments, the proof of the policy pudding must be in the eating (the results it delivers). There is no precedence for negative real rate of interest. Therefore, its impact on investment activity is in the realm of theory. In theory, with negative real rate of two percent, the Rocky Mountains can be levelled. The question is if they will be. Behavioural theories suggest that low rates boost speculation because they signal pessimism about future economic growth rather than optimism.
(5) There are other costs as well. Asset bubbles create behavioural impacts. Executive compensation is inflated as greed focuses on boosting share prices and benefiting further from it. Earnings (per-share) manipulation through financial engineering, rather than capital investment, is the result of low interest rates.
As the wealth of those who have financial assets rises faster, inequality and not investment is the consequence of low real rates. The ratio of executive to worker compensation in the US is worsening again. In 2013 the CEO-to-worker pay ratio was 331:1 and the CEO-to-minimum-wage-worker pay ratio was 774:1 [Link].
The chain of causality from low interest rates to income inequality runs through asset markets, executive compensation practices and both regulatory and shareholder forbearance of such practices. The fountain-head is low interest rates that stoke bubbles and greed simultaneously.
(6) As for secular stagnation, Bernanke cites some other academics and commentators who have dismissed that thesis. That does not necessarily mean that they are right. Ultimately, the answer to most debates in economics must lie in data and experience and not in theories or blog posts.
The one-off fruits of industrial revolution were harvested late in the eighteenth and in the nineteenth century. Already in the twentieth century, the world ran into limits of industrial revolution. Global economic growth was ‘rescued’ by two World Wars. Then, in the 1980s, it was rescued by the rise of previously slow-growing countries with giant populations, globalisation, glut in commodities and, above all, through the relentless and rapid rise in global debt levels. Growth was borrowed from future, literally. That ended in 2008. Policymakers have sought to continue that process of debt-driven growth. Hence, future growth is even more violently squeezed into the present.
In effect, the attempt to prove the ‘Secular Stagnation’ hypothesis wrong would end up achieving the opposite.
Industrial Revolution itself was as much as a product of an accident of nature (the Great Plague that raised the relative cost of labour vs. capital) as much as it was about human ingenuity. Low growth was the enduring reality of the 18 centuries of the Common Era. The last two centuries might have been an aberration or a historical accident. We will find out soon.
Even if this hypothesis of ‘growth spurt being an accident of history or nature’ turns out to be incorrect, from the policymakers’ perspective, it is prudent risk management to act as though it has a high probability and not to squeeze the growth juice dry right now, with all the other attendant consequences for resources, for climate, for human health, etc.
Monetary policymakers have left themselves and the world with little margin for error. If nothing else, this is in itself a colossal failure, for they incessantly swear by prudence and risk management while disregarding them in practice. That alone is a severe indictment of Bernanke and his ilk, more than anything else.