Project Syndicate: 9 February 2016
BRUSSELS – For the better part of a decade, central banks have been making only limited headway in curbing powerful global deflationary forces. Since 2008, the US Federal Reserve has maintained zero interest rates, while pursuing multiple waves of unprecedented balance-sheet expansion through large-scale bond purchases. The Bank of England, the Bank of Japan, and the European Central Bank have followed suit, each with its own version of so-called “quantitative easing” (QE). Yet inflation has not picked up appreciably anywhere.
Despite their shared struggles with deflationary pressures, these countries’ monetary policies – and economic performance – are now diverging. Whereas the United States and the United Kingdom are now growing strongly enough to exit their expansionary policies and raise interest rates, the eurozone and Japan are doubling down on QE, pushing policy long-term interest rates further into negative territory. What explains this difference?
The short answer is debt. The US and the UK have been running current-account deficits for decades, and are thus debtors, while the eurozone and Japan have been running external surpluses, making them creditors. Because negative rates benefit debtors and harm creditors, introducing them after the global economic crisis spurred a recovery in the US and the UK, but had little effect in the eurozone and Japan.
This is not an isolated phenomenon. By now, most of the world’s creditor countries – those with large and persistent current-account surpluses, such as Denmark and Switzerland – have negative interest rates, not only for long-term governments bonds and other “riskless” debt, but also for medium-term maturities. And it is doing little good.
Despite the weak impact of low interest rates, central banks in these economies remain committed to them. If it is suggested that QE or lower interest rates are unlikely to benefit their economies much, they shift the focus of the discussion, railing against the notion that raising interest rates would stimulate the economy – an ostensibly airtight argument. Only it is actually far from airtight.
Basic economics courses cover the curious case of the “backward-bending supply curve of savings”: In some circumstances, lower interest rates can lead to higher savings. Because lower rates reduce savers’ income, they spend less, especially if they have a savings target for their retirement.
None of this discredits the general rule – which forms the basis of modern monetary policymaking – that a lower interest rate tends to stimulate consumption and other expenditure. The impact simply varies according to the economy’s debt position.
In a closed economy, there is a debtor for every creditor, so whatever creditors lose from ultra-low interest rates, debtors should gain. But in an economy with a large net-foreign-asset position, there are naturally more creditors than debtors. For a country with large foreign debts, the opposite is true. The effectiveness of monetary policy at the lower bound should thus be different in creditor and debtor economies.
Until recently, this condition did not matter, because foreign-asset positions were usually small (as a percentage of GDP). Today, however, these positions in the major industrial economies are large and increasingly divergent, partly owing to the buildup of leverage that led to the global financial crisis of 2007-2008. And, in fact, at the international level, leverage is continuing to grow.
Though current-account imbalances have generally fallen since the financial crisis began, they have not reversed. This implies that the surplus countries continue to strengthen their creditor positions, diverging from the deficit economies.
Commodity exporters like Russia and Saudi Arabia, which ran large current-account surpluses when oil prices were high, are the main exception to this pattern of diverging foreign-asset positions. With the precipitous decline in world oil prices since June 2014, their fortunes have reversed. Their export earnings have plummeted – falling by half in many cases – forcing them to run deficits and draw on the large sovereign-wealth funds they accumulated during the global commodity boom. A radical reduction in expenditure has now become unavoidable.
The industrialized economies face very different challenges. Their problem – in a sense, a luxury problem – is to ensure that their consumers spend the windfall from lower import prices. But in the creditor countries, negative rates do not seem to advance this goal; indeed, some external surpluses are even increasing.
This divergence is also playing out within the eurozone. Though it is a creditor economy overall, it comprises debtor countries as well. The debtor economies, such as Spain and Portugal, now run small current-account surpluses, and are gradually reducing their debt. But the traditional creditors have seen their current-account surpluses grow so much that the debtor/creditor asymmetry continues to increase.
Most notably, since the start of the financial crisis, Germany's current-account surplus has increased to nearly 8% of GDP, meaning that the country has accumulated more surpluses in that period than in its entire previous history. On current trends, the German creditor position might rise from 60% of GDP to 100% of GDP.
Central bankers are supposed to be patient. Indeed, economists supported the global movement toward central-bank independence precisely because it seemed that central bankers would be less inclined to try to stimulate the economy for short-term gain. But central bankers seem to have become impatient, fretting about low inflation, even though the output gap is slowly closing and full employment has been reached in the US and Japan.
Creditor countries’ central bankers must stop trying to manipulate their economies with more potentially counterproductive monetary easing. Instead, they should allow the recovery to run its course, even if that happens slowly, and wait for the base effect of lower oil prices to disappear. ECB President Mario Draghi recently admitted that, in today’s global context, the current monetary-policy approach might not be effective. But promising more of the same is not the answer.
