In the face of unprecedented actions to safeguard public health, government-mandated lockdowns have seen global economies in free-fall. In response, central banks have embarked on several innovative monetary and fiscal measures. Official short-term interest rates were cut to record lows in most advanced economies. In some jurisdictions, like in the EU and Japan, rates have dived further into negative territory. But more importantly, the key global central banks (US, EU, Bank of Japan, UK and others) are effectively buying up all of the debt issued by governments, at the behest of these same governments, through quantitative easing or QE.
No guarantees of real economic recovery
However, none of their monetary actions can guarantee economic recovery. Indeed, if the experience of the decade since the financial crash is anything to go by, negative interest rates and quantitative easing are not sufficient – though they may be necessary – to create a healthy or durable economic recovery or inflation if growth remains weak.
Whilst central banks can help to foster better liquidity and so boost capital markets, they cannot create economic recovery, which depends on variables outside their control. In the case of established, advanced economies, an ageing population, excess savings, more significant uncertainty and low productivity mean that growth has been lacklustre since 2008/9. Emerging markets, of course, are a different story, as they can still expand rapidly by adopting best management practices from elsewhere, utilising current levels of technology and better governance.
At present, recovery has begun as lockdown measures are eased. However, it is clear that –without an effective vaccine or course of treatment – recovery will be slow and painful. Indeed, it could quickly go into reverse if partial lockdowns are imposed, as seems likely. Further fiscal and monetary loosening is, therefore, likely.
A side effect is that QE fuels the wealth of the already rich – widening wealth inequality
The expansion of fiscal policy that we have seen is fuelling equity prices. Increased liquidity has led to a fall in returns from holding government assets relative to return from investments in the private sector. Such ‘growth’ also heightens wealth inequality. Holders of capital market assets gain from the downturn compared to those whose wealth is based on income, and this creates wealth or asset inequality. How that plays out politically amidst the pandemic message of us all being ‘in it together’ could exacerbate existing dissatisfaction.
Rates can go even lower
The recent US Federal Reserve statement that zero interest rates and QE would remain until annual consumer price inflation is at 2% and heading higher, also seems to ignore the fact that there is no evidence that central banks can create inflation, as Japan’s experience demonstrates. Despite negative interest rates, Japan has continued to suffer from negative rates of inflation year in year out, due mainly to a falling, and an ageing, population.
We may, therefore, be in for an extended period of low or negative interest rates. Indeed, a long run (500-year or half a millennia) study of real long interest rates suggests that they have been falling for centuries. Other research shows that pandemics can result in inflation-adjusted long-term rates of return on ‘safe’ assets below the long-run average for up to 40 years.
After it’s September MPC meeting, The Bank of England said that it would undergo preparations to allow for negative interest rates in the UK. That’s not to say that it is planning to do it. Rather, it is to say that, as 2021 approaches, and economic storm clouds seem to be gathering (a no-deal or limited Brexit deal, and risk of other lockdowns owing to Covid-19), the possibility that they may have to is significant enough for them to plan for it. If they did implement negative rates, they would join a club of countries that are already in such a position.
The gap between income and capital widening
Meanwhile, the reality for many of those in work across the world since the 2008/9 global financial crisis is that real incomes have stagnated. Yet, in the same period in the UK and other market economies, those with access to housing assets have seen rises of 40 to 50% in values. And those with access to equities and bonds have seen rises of around 60%. Research both here and in the US has shown that the majority of people are living from ‘pay cheque to pay cheque’ with little or no savings to fall back on.
Such a gap will spark political and social issues if left unaddressed. It may be happening already. Remember the ‘just about managing’ that Theresa May as Prime Minister mentioned so often? The lack of a sustained recovery since the global financial crisis despite record low-interest rates means merely cutting rates and monetary policy seem not enough to guarantee a sustained rise in living standards.
There are solutions
Time perhaps to dust off solutions and for structural reform – just as the toolkit for monetary policy has been expanded – that focuses on boosting productivity and opportunities for new skills for those on lower pay, the unemployed and those joining the workplace. Many of these solutions are, in fact, well known and indeed not rocket science.
Start with initiating life-long learning programmes, so skills are always updated. Just last week, the UK government mooted a plan along these lines for adults. Technical centres focussed on coding, internet skills, data scientist skills, and careers advice centres in every major area. Decentralisation of decision-making back to the local authority level for business rates, schools, and social house building would be beneficial. A focus on public investment in the skills of digitisation and the jobs of tomorrow is required. These, and, thankfully, other ideas too numerous to list, would be a good start.