The beginning of the year is traditionally a flood of various types of economic forecasts and analyzes. Widely read and carefully analyzed, because the level of uncertainty is high today. Today I would like to focus on one thread that stands out in most publications. It is about changing the way of thinking about fiscal and monetary policy: universal acceptance of high deficits and their simultaneous financing by central banks.
For some, this change is justified by the current situation: extraordinary circumstances (pandemics) require extraordinary action. For others – taking a longer perspective – it is a kind of sanctioning processes that have been going on for years (not to say decades); as public debt globally is in a sustained upward trend, there was a need to create a new narrative that would sanction such a state. All the more so as the negative experiences with the austerity policy imposed on some countries not so long ago (sometimes in a completely non-reflective manner) created favorable conditions for the emergence – or in fact a rebirth – of another mythology, this time that national public debt is not a problem. In extreme forms of this myth, you can even hear that at zero interest, public debt “costs nothing”.
I remember well how, during the financial crisis of 2009, there was a widespread belief that the quantitative easing policy – which was only just entering the salons at the time – would be exceptional, a short-lived episode in the world’s economic history. The vast majority of economists assumed that central banks would be able to withdraw from it without any problems. Today, from the perspective of several years that have passed since then, it can be said that something completely opposite happened; although some central banks – including the Fed – have made an attempt to return “to normal”, the trend is one: the more and more common (more countries and larger scale) use of central bank balance sheets to create liquidity and supply it to the economy, mainly to budgets.
If we take this long-term perspective, it is clear that what we are dealing with in fiscal and monetary policy is a one-way street: after the era of gradually declining interest rates, the era of zero (sometimes even negative rates) has come, and now we are entering the money phase. the central bank in an unlimited amount. This is because the obligations of central banks related to controlling the level of market interest rates are of this type – such a declaration means that the central bank will spend (create) any amount of money in order to achieve its goal (the assumed level of interest rates). This type of policy is already in place in Japan, and other large central banks will soon be forced to do so. It is hard to imagine that in the conditions of increasing inflationary pressure (in the area of assets and / or goods) they could allow for a significant increase in market interest rates; although central banks pretend that their actions are independent in nature, in practice they are increasingly becoming hostages to the fiscal situation.
Where can such a condition lead to? Is it a win-win situation or not? The answer is not unequivocal. Artificially lowered interest rates amidst more and more common symptoms of reflation (upward pressure on prices) is both good and bad news. It all depends on who you are talking about and what perspective is being taken into account.
In the short term (two or three years), this is good news for governments: with reflation, nominal values (GDP, tax base) increase, and at the same time the cost of debt servicing – as a result of interest rate control – remains low. The real cost of various types of budgetary liabilities that are not indexed (or partially indexed) to inflation is also falling. The government gains in yet another way – the market mechanism of public finance control is turned off.
Financial repression – this is the name of the practice of artificially lowering interest rates in relation to inflation – is bad news for all those who keep their savings in banks (they constantly depreciate). Also for those whose funds are invested in government debt securities. And this applies not only to retail buyers of Treasury bonds, but above all to institutional investors (pension funds, some investment funds, insurance companies, etc.). The second group that loses the most in such a situation are the poor, living on various types of social benefits (benefits, pensions, etc.). It is precisely these groups that are hit by the rapid expansion of the scissors between the value of the basket of goods and services they purchase and the growth rate of their income.
In the longer term, the effects of financial repression on capital allocation processes are of key importance. Cheap (or even free) capital creates a kind of privilege for speculative activity over real activity. In addition, it encourages the implementation of low-efficiency projects, and in the public sector of low social utility. There is short-term support for the economic situation from such projects, but at the same time there is a burden of long-term operating costs, which then over the years are absorbed by the central budget and / or local governments. Another side effect is the upsurge in the prices of commodities and capital goods, which can be especially strongly observed in the conditions of limited supply of resources.
A visible effect of disturbances in resource allocation mechanisms are various types of speculative bubbles (stocks, real estate, commodities, etc.), as well as the accumulation of assets that reduce the development potential in the long term (bringing down the average productivity of assets in a given economy). This gives rise to successive winners and losers. As a rule, bubbles are beneficial to seasoned investors (i.e. those who have “large capital”) at the expense of the broad category of “small savers” (usually they buy upstairs and sell downwards). On the other hand, the accumulation of unproductive assets is only a short-term benefit for construction companies and suppliers of investment goods, all of them lose in the long term.
Other long-term effects of financial repression result from changes in the relationship between labor and capital prices. If an increase in inflation translates into an increase in wages – which usually takes place in the absence of labor – then the relative competitiveness of labor versus capital / technology deteriorates rapidly. In other words, automation and robotization are accelerating. This applies in particular to the so-called simple work, but not only. If in a given country there are no proper mechanisms of adapting competences to changing conditions, then this is a straightforward way to serious social problems – more and more masses of the workforce do not meet the requirements of the local labor market.
To sum up, at the end of the path that fiscal and monetary policy is currently taking, the world will not be any better. It is “more of the same” that we have dealt with after the global financial crisis. The world will be more and more susceptible to various kinds of disruptions, and income inequality will increase. Along with this, social tensions will also increase. The current strategy is to continue “digging up the can for front “. The problem, however, is that this excavation is about to end – the can will bounce off the wall at the end of the cul-de-sac in a moment. So it’s high time to stop playing with the can and look for an alternative to your current approach. The essence of the change must be that capital allocation mechanisms prefer investing in productive assets, rather than financing speculation and the diseased (zombie) part of the economy.
Published: Parkiet, 17.02.2021