Martin Sandbu, I think, outdoes himself in his latest column. He says that central banks were not loose enough in the years following the crisis as, even after the latest Trump tax cut stimulus in the US, inflation rates are not picking up and therefore, spare capacity was much higher. If only central banks had been bolder, the negative output gap would have closed much earlier!
The certitude here is indeed breathtaking. It took my breath away for a minute. I just did not know where to begin.
The simple truth is that monetary policy has been completely orthogonal to the real economy developments after the crisis. The economies of America and Europe have recovered on their own because monetary policy has been so loose for so long that such a belated recovery cannot be attributed to policy effectiveness.
It is wrong to argue that central banks had not done enough. By April 2010, the S&P 500 had nearly doubled (up 81%) from its low in February 2009. The 10-year bond yield had crashed from 4.0% to 2.0%. Everytime it threatened to rise above 4.0%, the Federal Reserve did QE2 and QE3. It did not raise rates in 2014. In 2015 and in 2016, it raised rates by 25 basis points each – 0.5% in total in two years! Mr. Sandbu thinks that they were not bold enough?!
Monetary policy operates through financial market variables. Where was the wealth effect from these reactions in bond yields and in the stock market? Nothing.
Had the Federal Reserve been more reckless, it would have sent financial assets to even greater heights but to what effect on the real economy?
It would have only widened the inequality and the angst among the middle and lower classes. Hasn’t he seen the UK Housing Affordability Index released by the Office for National Statistics for 2017?
On average, full-time workers could expect to pay around 7.8 times their annual workplace-based earnings on purchasing a home in England and Wales in 2017, a significant increase of 2.4% since 2016.
Workplace-based housing affordability significantly worsened in England between 2016 and 2017, but there were no significant changes in Wales.
Housing affordability has worsened significantly in 69 local authorities in England and Wales over the last five years, with over three-quarters of these being in London, the South East and the East.
All but five London boroughs had significant worsening of affordability since 2012.
House prices and earnings increased in all English regions and Wales, but the two regions with the largest increase in house prices (the East (10%) and the South East (6.9%)), were the two regions with the significant differences over the year. This suggests that house prices are driving the significant worsening in affordability.
The affordability ratio has more than doubled for every property type in England from 1997 to 2017. [Link]
Right after the Brexit vote, the Bank of England had taken out a pre-emptive monetary policy accommodation insurance on top of the ultra-loose monetary policy that prevailed. Yet, Mr. Sandbu thinks that policy wast not loose enough!
Given continuously worsening affordability caused by asset price increases which are a consequence of monetary policy, does he reckon with the social and economic costs of his implicit recommendation that central bankers should have been more reckless than they already were? May be, Brexit would have been forced on David Cameron than him calling for a referendum on the matter.
May be, Trump would have won with an even bigger margin or Bernie Sanders would have won the Democratic Primaries notwithstanding all the attempts to stop him from winning it.
The Chicago Fed Financial Conditions Index is hovering near the easiest despite the Federal Reserve hiking interest rates gradually since 2015 (data as of July 27, 2018 was available at the time of writing this blog post). It only shows that the normalisation is proceeding at such a glacial pace that it is hardly registering on the financial conditions.
Graeme Wheeler, then Governor of the Reserve Bank of New Zealand said this in October 2015:
Monetary policy is, however, relatively powerless to influence the decisions that determine long-run economic performance and distributional outcomes. For example, over the long run, monetary policy can do little to generate higher spending by households and firms. Even in the shorter term, monetary policy’s influence may be low in an environment where debt levels are high and where there is considerable uncertainty about economic prospects.
Monetary policy can influence risk-taking in asset markets, but this does not necessarily translate into risk taking in long term real assets – requiring the investment and entrepreneurial decisions that underpin productivity growth and hence long-run improvements in living standards. [Link]
A gentleman (Ben Carlson) had posted a comment under Martin Sandbu’s column implicitly supporting him by providing a link to his blog post.
My comments on that are as follows:
(1) The Fed’s remit is, officially, not the stock market index
(2) Earnings improvements were a functioning of low interest rates as top lines did not improve much for quite some time after 2009. Federal Reserve policy was powerless to influence aggregate demand and real economy. See Graeme Wheeler’s comments.
(3) Most ordinary people save through bank deposits. They were robbed of their incomes even as asset prices went up.
(4) Household debt has fallen but corporate and other debt have risen significantly. Overall leverage of the U.S. economy has only increased despite the crisis having been caused by leverage
(5) The improvement in household networth says nothing about its distribution. For that, check out the work (‘A lost generation’) by the Federal Reserve Bank of St. Louis on whose networth has improved. Mr. Ben Carlson’s stock market performance would not make a difference to them.
(6) If one taunts the Fed sceptics that their criticism was a reflection of ‘sour grapes’, it is equally possible that one’s approval of Fed policy is a reflection of their personal riches. Social and public welfare consequences be damned.
Resilience of human irrationality, a I wrote in my MINT column two weeks ago, is remarkably strong.