In 2009, a small group of analysts dared to question whether emergency stimulus measures were the beginning of the “Japanization” of Europe and the U.S. Ultralow interest rates, large budget deficits and then quantitative easing were all meant to be temporary. Seven years later, only the most optimistic could see these measures being put away soon.
In 2014 Larry Summers called the current malaise “secular stagnation.” The secular part implies the change is not cyclical but has become entrenched. The stagnation part means that there is little or no growth. This year the mainstream business news (i.e. Bloomberg, not just Zero Hedge) has started regularly publishing articles questioning whether orthodox economic policy has any answers left.
Orthodox economists and central bankers are openly saying that monetary policy has reached its limits and the answers must be found elsewhere.
While there might be a consensus that monetary policy isn’t working, there isn’t a consensus on whether fiscal policy is the solution. At one end of the spectrum, Paul Krugman argues that bigger government deficits are the answer. At the other end there’s a growing group that thinks orthodox economics continues to ignore debt and therefore hasn’t correctly diagnosed the problem. If the diagnosis is wrong, the remedy is almost certainly wrong as well.
Like many, it is as a result of the financial crisis and being part of debt markets that I’ve come to understand how important debt is in the functioning of an economy. Incorporating debt into economic analysis is a lightbulb moment. Easy and cheap debt creates overcapacity in economies. Examples include property and infrastructure in China, the recent U.S. energy boom and the precrisis housing boom in the U.S. Overcapacity is typically cleaned out in a recession, but the ongoing global wave of bailouts hasn’t allowed this natural process to occur.
How debt and interest rates impact an economy
It is often said that debt is a mechanism for bringing consumption forward, producing a quick stimulus in an economy. However, the interest and principal payments required become a long-term drag on spending in the future. When reviewing monetary policy in this light, the failure to stimulate economies becomes easier to understand. Businesses see overcapacity and reduce investment. Cheaper borrowing rates just encourage borrowing for stock buybacks and acquisitions. Supply stays the same; it’s just the ownership that changes hands.
For consumers with savings, lower interest rates reduce their income, so they respond by cutting spending or moving to riskier investments. As with businesses, the switch to riskier investments primarily results in bidding up prices for existing assets. For consumers with debt, their repayments rarely change; rather, the lower interest rates see their debt repaid faster. This has an impact over the long run, but in the short and medium term there is no additional discretionary cash in the household budget.
For those looking to borrow for housing, their savings build more slowly and repayments when they do buy a property will be higher as house prices are higher.
The hoped-for wealth effect from inflated asset prices hasn’t arrived. Consumers aren’t spending more and businesses don’t need to expand, so demand for labor has been slow to recover. Real disposable incomes are barely growing or negative. Consumers see their economic situation as worse, regardless of an increase in the value of their house. Low interest rates are seen as marking an economic emergency, rather than being a green light to spend money.
Why fiscal policy doesn’t help
What about fiscal policy? Here the logic is much simpler. By increasing debt now, future generations are burdened with higher repayments. Some argue that governments should use current low interest rates to spend on infrastructure and thus increase productivity and growth. In theory that sounds logical. In reality, it’s about allowing currently excessive levels of stimulatory spending to continue. If a government has $100 of income, it should spend $80 on stimulatory spending and $20 on investment rather than $100 on stimulatory spending and borrowing $20 for investment. Even better would be to spend $70 on stimulatory spending, $25 on investment and $5 on reducing debt levels.
Will We Get Tax Reform?(4:16)
U.S. Representatives Kyrsten Sinema (D., Ariz.) and Steve Stivers (R., Ohio) of the Congressional Caucus for Middle Market Growth speak with WSJ Washington Bureau Chief Jerry Seib about the likelihood of tax policy reform in the near future.
So if further stimulation by monetary and fiscal policies isn’t the answer, what is? The actions required are all about prioritizing reform and productivity. Firstly, government spending and taxation needs to switch from temporary relief to long-term growth measures. Secondly, businesses must be given greater scope to compete and reduce their costs.
What does reform of government spending and taxation look like? If welfare is curtailed, working people pay less in taxes and spend more (creating more demand for goods and services), and unemployed people are given more incentive to seek work. On the taxation side, reforms that promote greater employment need to be prioritized. This means reducing income-tax rates so that the treatment of employment income and investment income is equalized.
Reducing regulation to allow greater competition can be difficult to sell. Many people get a small win while a vocal few suffer larger losses. Uber is perhaps the most famous example. It’s often been said that taxis are the best advertisement for Uber. The service is often poor and the costs are higher than they should be. Primarily as a result of not needing to earn $30,000-$50,000 a year to cover the investment in a taxi license, Uber can offer lower fares.
Uber isn’t perfect — there are legitimate concerns about Uber skirting tax obligations and minimum wage levels — but having monopoly controls on taxi services was far worse. Research has found that while Uber has taken market share away from taxis, the overall market has grown. Consumers are demanding more of the same service because the price has fallen.
If similar reforms were applied across an economy, the benefits would be substantial.
Jonathan Rochford is a portfolio manager at Narrow Road Capital, which specializes in high-yield and distressed credit. This commentary is adapted from “Monetary and Fiscal Stimulus Has Failed — What Next?”
In 2014 Larry Summers called the current malaise “secular stagnation.” The secular part implies the change is not cyclical but has become entrenched. The stagnation part means that there is little or no growth. This year the mainstream business news (i.e. Bloomberg, not just Zero Hedge) has started regularly publishing articles questioning whether orthodox economic policy has any answers left.
Orthodox economists and central bankers are openly saying that monetary policy has reached its limits and the answers must be found elsewhere.
While there might be a consensus that monetary policy isn’t working, there isn’t a consensus on whether fiscal policy is the solution. At one end of the spectrum, Paul Krugman argues that bigger government deficits are the answer. At the other end there’s a growing group that thinks orthodox economics continues to ignore debt and therefore hasn’t correctly diagnosed the problem. If the diagnosis is wrong, the remedy is almost certainly wrong as well.
Like many, it is as a result of the financial crisis and being part of debt markets that I’ve come to understand how important debt is in the functioning of an economy. Incorporating debt into economic analysis is a lightbulb moment. Easy and cheap debt creates overcapacity in economies. Examples include property and infrastructure in China, the recent U.S. energy boom and the precrisis housing boom in the U.S. Overcapacity is typically cleaned out in a recession, but the ongoing global wave of bailouts hasn’t allowed this natural process to occur.
How debt and interest rates impact an economy
It is often said that debt is a mechanism for bringing consumption forward, producing a quick stimulus in an economy. However, the interest and principal payments required become a long-term drag on spending in the future. When reviewing monetary policy in this light, the failure to stimulate economies becomes easier to understand. Businesses see overcapacity and reduce investment. Cheaper borrowing rates just encourage borrowing for stock buybacks and acquisitions. Supply stays the same; it’s just the ownership that changes hands.
For consumers with savings, lower interest rates reduce their income, so they respond by cutting spending or moving to riskier investments. As with businesses, the switch to riskier investments primarily results in bidding up prices for existing assets. For consumers with debt, their repayments rarely change; rather, the lower interest rates see their debt repaid faster. This has an impact over the long run, but in the short and medium term there is no additional discretionary cash in the household budget.
For those looking to borrow for housing, their savings build more slowly and repayments when they do buy a property will be higher as house prices are higher.
The hoped-for wealth effect from inflated asset prices hasn’t arrived. Consumers aren’t spending more and businesses don’t need to expand, so demand for labor has been slow to recover. Real disposable incomes are barely growing or negative. Consumers see their economic situation as worse, regardless of an increase in the value of their house. Low interest rates are seen as marking an economic emergency, rather than being a green light to spend money.
Why fiscal policy doesn’t help
What about fiscal policy? Here the logic is much simpler. By increasing debt now, future generations are burdened with higher repayments. Some argue that governments should use current low interest rates to spend on infrastructure and thus increase productivity and growth. In theory that sounds logical. In reality, it’s about allowing currently excessive levels of stimulatory spending to continue. If a government has $100 of income, it should spend $80 on stimulatory spending and $20 on investment rather than $100 on stimulatory spending and borrowing $20 for investment. Even better would be to spend $70 on stimulatory spending, $25 on investment and $5 on reducing debt levels.
Will We Get Tax Reform?(4:16)
U.S. Representatives Kyrsten Sinema (D., Ariz.) and Steve Stivers (R., Ohio) of the Congressional Caucus for Middle Market Growth speak with WSJ Washington Bureau Chief Jerry Seib about the likelihood of tax policy reform in the near future.
So if further stimulation by monetary and fiscal policies isn’t the answer, what is? The actions required are all about prioritizing reform and productivity. Firstly, government spending and taxation needs to switch from temporary relief to long-term growth measures. Secondly, businesses must be given greater scope to compete and reduce their costs.
What does reform of government spending and taxation look like? If welfare is curtailed, working people pay less in taxes and spend more (creating more demand for goods and services), and unemployed people are given more incentive to seek work. On the taxation side, reforms that promote greater employment need to be prioritized. This means reducing income-tax rates so that the treatment of employment income and investment income is equalized.
Reducing regulation to allow greater competition can be difficult to sell. Many people get a small win while a vocal few suffer larger losses. Uber is perhaps the most famous example. It’s often been said that taxis are the best advertisement for Uber. The service is often poor and the costs are higher than they should be. Primarily as a result of not needing to earn $30,000-$50,000 a year to cover the investment in a taxi license, Uber can offer lower fares.
Uber isn’t perfect — there are legitimate concerns about Uber skirting tax obligations and minimum wage levels — but having monopoly controls on taxi services was far worse. Research has found that while Uber has taken market share away from taxis, the overall market has grown. Consumers are demanding more of the same service because the price has fallen.
If similar reforms were applied across an economy, the benefits would be substantial.
Jonathan Rochford is a portfolio manager at Narrow Road Capital, which specializes in high-yield and distressed credit. This commentary is adapted from “Monetary and Fiscal Stimulus Has Failed — What Next?”
