Chained to zero

On 26 August, Marin Sandbu wrote in ‘Free lunch’ that central banks should be thinking of doing more to kindle borrowing rather than thinking of raising rates:

The overall lesson, of course, is that asking how soon central banks should raise rates is as wrong-headed a debate as it is possible to have. The question is how, and by how much, they should loosen monetary policy further, not tighten it. [Link]

This is what I wrote as a comment on his column:

Where did that last paragraph come from and why? One writes a whole piece wondering why an unprecedented policy accommodation from around the world has done zilch to engender confidence and investment and then concludes abruptly that more of it is needed. Evidence of herding of thoughts and scant regards for the law of unintended consequences. Since 1980, current dollar GDP of advanced economies has gone up by 5.62 times while their public debt has gone up by 14.4 times. Bulk of global growth since AD 1 has occurred in the last thirty five years, propelled by an even faster rise in debt. How much more of GDP growth can debt help us borrow from future and at what cost?

He remains unfazed. He was at it again. In the latest edition of ‘Free lunch’ posted on September 8, he again concludes that more is needed:

None of this means that QE should not have been implemented in the various economies it has been. On the contrary: if these considerations mean we should not be surprised by QE’s rather weak effects, that is an argument for doing more not less of it. It is also, of course, an argument for looking beyond QE at more powerful monetary policies, in particular those that may be thought to have a more direct effect on expected demand, so as to coax businesses into taking up the extraordinary loan conditions on offer. The case for more negative interest rates and monetary helicopters is not going away. [Link]

Rather sad to see the blinkered approach by a man who, I thought, was capable of greater clarity and sharpness of thinking.

Another person I used to have enormous respect for, was Andrew Haldane of the Bank of England. He was the Director for Financial Stability. His speeches and insights were exceptionally rich. Ever since he became the Chief Economist of the Bank of England, he had decided that the financial stability belonged to another silo and that all that mattered in his new role was the silo of real economy. Hence, he has been cautioning the Bank of England against raising interest rates. This is the most recent example. Rather sad.

Of course, predictably, Martin Wolf too has cautioned the Federal Reserve against raising interest rates. This is the comment I left beneath his latest column:

It is amazing, isn’t it? The last crisis was caused by central banks focusing on inflation to the near-total exclusion of other warning indicators. Writers like Martin Wolf pretended to get the lessons after the crisis. When it is time to take a stance, they go back to their familiar script: inflation is low and therefore, let rates be low.

His recommendation is an acknowledgement of the state to which the world is condemned to remain at, by the financial cycles that central banks fan and ignore simultaneously. Our fear of the downside of the financial cycles that central bankers have encouraged condemns the world economy to perpetually low rates.

As BIS had written so eloquently in its latest annual report too, low interest rates beget even lower interest rates.

Disappointing and yet unsurprising stuff from Martin Wolf.

Mr. ‘Free Lunch’ (Martin Sandbu) cites a column by Mark Gilbert in Bloomberg Views as to why the UK should not raise interest rates now.

Mr. Kaushik Basu was the former Chief Economic Advisor to the Government of India and before that, he was a Professor at Carnegie-Mellon University. He is now the Chief Economist of the World Bank. He too has chimed in with his call to the Federal Reserve to hold its interest rate fire. When Ken Rogoff was at the IMF and Joseph Stiglitz at the World Bank, they were breathing fire at each other, during the Asian crisis, on the policy prescriptions suggested by the IMF, for the Asian economies.  At least, there was much to learn from their intellectual (and, sometimes, not-so-intellectual) battle. Now, we have both the IMF and the World Bank on the same page!

Well, Kaushik Basu is in good company. His predecessor (not immediate) Joseph Stiglitz too is calling on the Fed not to raise interest rates. Calls it a ‘no brainer’. I suppose so. Keeping interest rates chained to the zero floor is an indication of no brains, indeed. It is very sad that, ever since, he had that fight with Ken Rogoff in 1997-98, Joseph Stiglitz has allowed the label of a ‘left-liberal’ economist to dictate his position rather than economic circumstances and context.

The argument for raising interest rates focuses not on the well-being of workers, but that of the financiers [Link]

Joe Stiglitz gets the argument wrong by 180 degrees! Interest rates kept at zero have down exactly what he does not want to see: they have helped financiers, speculators, stock buybacks and contributed to rising inequality.  Ordinary Americans have either left the labour force or those stayed in got jobs with low pay-long hours.

Looks like financial cycles matter only to those economists at the Bank for International Settlements. I am almost through with the first three chapters of the annual report of the Bank for International Settlements. All these gentlemen must read and reflect on it. They are condemning the world to a cycle of low and lower rates and even lower returns and impact to show for it.

What BIS wrote in their annual report (Chapter 1): ‘low rates beget even lower rates’ is echoed in the following lines captured in a FT article on why investments are not picking up in Europe on the back of lower interest rates:

If the cost of capital reflects the low interest rate environment, then so will the cash flows.” Bernd Scheifele, chief executive of HeidelbergCement, the cement maker, says: “The problem in a world of zero interest rates is that it’s very difficult to find projects where you can still earn the WACC within a foreseeable future.” [Link]

Thoughtful people will see the self-defeating nature and counterproductive outcomes of ultra-easy monetary policies. But, what we have is this: intellectual herding, laziness and disregard for the law of unintended consequences. It is a very dangerous combination. The world will pay a high price for this. Again.


5 thoughts on “Chained to zero

  1. Malinvestment can occur, but the high PEs are the intended, though perhaps not explicitly stated, result of policy to drive investment and hopefully enable growth drivers to arise in industries such as power, ICE industries etc. till conventional AD comes back, either by EMs (mainly China) rebalancing and, by currency effect, the U.S. re-industrializing partly.

    I know it’s anathema for Austrian School-ers, this Fed-knows-best policy, but can’t hold the view both that the market is irrational (as you find the 80 PEs crazy, which they are I agree) and at the same time think the market would correct itself in an orderly, non-economy-damaging fashion without Fed intervention.

    Bottomline: I respect your viewpoint, and like your blog even though my disagreements might suggest otherwise, which I certainly hope that they do not, i.e. suggest I’m trolling. Thanks.


    1. Why would I be unhappy that someone finds the time to read my blog and is interested enough to comment on it? Thanks much. There is much to disagree with, on your first two paragraphs. One, markets are irrational, short-term (voting machines). Long-term, they are weighing machines. We are talking about the real economy correcting itself without Fed intervention. Not the market. In fact, the problem is the abject failure on the part of the Federal Reserve to distinguish between the two – financial markets and the real economy.

      On a slightly different note, we do not need a central bank at all. As Srini Thiruvadanthai used to say and still says, it is Central Planning.


  2. Your points are very well-taken and that cement company CEO statement is pretty stunning. though it does not gel somewhat with one of your blog posts earlier, where you highlighted a Fed survey of CEOs in the US that revealed that their WACC estimates were insensitive to interest rates…but what if the natural rate of interest is indeed zero in developed economies, or at least the U.S.? Even negative? Till the baton is passed to EMs (or if), the lack of AD has to be addressed through the available monetary levers, however bad their, or even in some cases ineffective, their side-effects…? And is there any research or explanation as to what is the transmission channel in reflating economies that starts with increasing interest rates, even while inflation remains quiescent…?


    1. It does gel. He says that one cannot earn enough to meet the WACC in low (or, zero) interest rate environment. So, it means that WACC/Hurdle Rate remains high/unchanged and that cashflows are hurt. If natural rate is zero, what are stocks doing at 19 times P/E in S&P 500 and more than 80 times P/E with Russell 2000 stocks? Why are policymakers encouraging that? If they collapse, the natural rate can go negative then. Perhaps, that is what they want. The problem is not lack of AD but too much of AD before.


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