At the end of every August, the central bankers of the world meet in the ski resort of Jackson Hole, Wyoming, USA to discuss the state of the world economy and the role of monetary policy in improving it. These central bankers hear presentations from top mainstream academic economists and make speeches on how they see things. This year, the symposium starts today with both Janet Yellen, head of the US Federal Reserve (to be replaced by Trump next year) and Mario Draghi of the European Central Bank delivering an address.
In previous years, the main theme has been on how to ease monetary policy (ie lower interest rates and print more money) in order to save the banking system and stimulate the capitalist economy into recovery from the Great Recession.
In 2013, the cry was for ‘quantitative easing’ (QE). This was the policy idea that central banks, as the ‘last lender of resort’, would pump money into the economy by buying all sorts of financial assets from the commercial banks and other financial institutions (mainly government bonds, but also corporate bonds, mortgage bonds and even stocks and shares). In this way, they would fill the coffers of the banks with funds to lend on to households and corporations.
This ’unconventional monetary policy’ was adopted by the Fed, the ECB and the Bank of Japan big time. The balance sheets of these central banks rocketed. The US Fed now has $4trn worth of bonds and other assets on its books, funded by the creation of more dollars. The ECB is heading for over $3trn too after it launched another QE program in 2015.
And the BoJ’s QE plans have taken its balance sheet up to 75% of the equivalent of Japan’s GDP!
But has it worked? The answer is no. Back in 2013, the Jackson Hole attendees were told by Vasco Curdia and Andrea Ferrero at the Federal Reserve Bank of San Francisco (Efficacy of QE) that the Fed’s QE measures from 2010 had helped to boost real GDP growth by just 0.13 percentage points and the bulk of this ‘boost’ was thanks to ‘forward guidance’, namely convincing investors that interest rates were not going to rise. If that factor had been left out, the US real GDP would have risen only 0.04 per cent as a result of QE.
Two years later, Stephen Williamson,vice-president of the Federal Reserve Bank of St Louis, issued a study in which he concluded : “There is no work, to my knowledge, that establishes a link from QE to the ultimate goals of the Fed – inflation and real economic activity. Indeed casual evidence suggests that QE has been ineffective.”
This ought to have been no surprise because back in the 1930s during the Great Depression, John Maynard Keynes also concluded after a few years that quantitative easing was a failure. Pumping money into the banks did not boost the post-1929 US economy. Eventually, Keynes opted for fiscal spending and government investment as the only policy to get out of the 1930s depression.
Indeed, all QE has done is to create a huge bubble in the stock markets of the world, while economic growth has remained sluggish at average rates less than half before the Great Recession and real incomes for the average household (who had no stocks) flat or falling.
Nevertheless, under the influence of the monetarist school of mainstream economics founded by ‘free market monetarist’ Milton Friedman and expounded by his follower, former Fed chief Ben Bernanke, the central banks continued with QE.
At the beginning of 2016, the fear was that the major capitalist economies were slipping into a debt deflation slump and something new had to be done. Indeed, some central banks resorted to even more desperate measures of not just reducing the ‘policy’ (base) interest rates to zero (ZIRP) but further into negative interest rates (NIRP). In other words, central banks were paying commercial banks to take their new money!
But by the end of 2015, the US Fed, with an economy that was doing slightly better than elsewhere, decided to reverse the easy money policy. The Fed hiked its policy rate in December 2015 for the first time in nine years. Yellen explained that the US economy “is on a path of sustainable improvement.” and “we are confident in the US economy”.
This year’s discussion at Jackson Hole will not be about ‘unconventional monetary policy’ and the efficacy of QE. That has been forgotten and the debate has moved onto how to ‘normalise’ interest rates (raising them) in order to establish control over potentially rising inflation in an environment of ‘full employment’, without provoking a new recession. The title of this year’s symposium is Fostering a Dynamic Economy – apparently the world economy is now ‘dynamic’.
Indeed, all the talk is about how for the first time in ten years since the global financial crash, “a broad-based economic upswing is at last under way. In America, Europe, Asia and the emerging markets, for the first time since a brief rebound in 2010, all the burners are firing at once.” All 45 countries tracked by the OECD are on track to grow this year and 33 of them are poised to accelerate from a year ago.
Neverthless, mainstream economics remains divided about whether it is a good idea for the Fed to continue to hike rates and sell off its QE purchased bonds, as it eventually plans. Keynesians like Larry Summers and Paul Krugman reckon such credit tightening would seriously damage consumer spending and investment and cause another credit crunch. They would prefer to keep the credit bubble going with cheap money, along with some more government spending on infrastructure etc, to avoid ‘secular stagnation’. Summers wrote that “a reasonable assessment of current conditions suggest that raising rates in the near future would be a serious error”.
On the other hand, the Austrian school of economics as represented by the Bank for International Settlements (BIS), reckons that to keep fuelling the credit bubble with cheap money and QE is presaging yet another financial crash down the road as debt in all the major economies is still too high. Credit bubbles lead to ‘malinvestment’ and low productivity. It is better to keep government spending curbed and to hike rates so that money is not spent on useless projects and the credit and stock market bubble is ‘pricked’.
Yellen cites full employment and potentially rising inflation as reasons for hiking interest rates now. But there is little sign of any pick-up in inflation. The so-called Phillips curve, namely the trade-off between low unemployment and higher inflation, beloved by Yellen and the Keynesians alike, is not in operation. It is flatter than eve (see graph below). Phillips was proved wrong in the 1970s when economies experienced, low growth, high unemployment and inflation (‘stagflation’). Now there is high employment (at least on official figure) but low inflation, low growth and low wages – stagnation.
The reality is that cutting or hiking interest rates has little effect on capitalist economies compared to the level of profitability in the capitalist sectors of the world economy. If profitability is improving, then interest rates could rise with little impact on the ‘real economy’, even if the stock market falls back. It is the profitability of capital that matters and from there to investment and growth.
In a recent post, I pointed out that both US and global corporate profits has staged something of small recovery in the last few quarters. But US domestic corporate profits have grown at an annualized rate of just 0.97% over the last five years. Prior to this period, five-year annualized profit growth was 7.95%. And profitability (profit as a percentage of capital invested) in the US is some 6% below its peak in 2006 before the Great Recession and after recovering to that peak by 2014, has been falling for the last two years (according to my calculations from AMECO data).
Moreover, at $8.6 trillion, US corporate debt levels are 30% higher today than at their prior peak in September 2008. At 45.3%, the ratio of corporate debt to GDP is at historic highs, having recently surpassed levels preceding the last two recessions. That suggests that increased costs of debt servicing from rising interest rates driven by the Fed’s ‘normalisation’ policy could tip things over, unless profitability recover for the wider corporate sector.
Jackson Hole was so named because it was set in a deep valley between the peaks of the massive Teton mountains. Will the central bankers there be right that the world economy is finally getting out of its hole and heading to the heights of the Tetons? We shall see.