The late Paul Volcker ended the stagflation of the 1970's in America through bold monetary policy, it's time we end the stagflation of the 2010's through some bold monetary policy of our own.
While recessions aren’t technically inevitable, they are functionally inevitable and as a large portion of economic activity has been suspended for a couple of months in many places across the world governments struggles to find ways of not just keeping populations safe but to avoid a protracted recession. I bring up the functional inevitability of recessions as an indictment of central bankers; their principal policy instrument is interest rates which need to be raised before rates can be lowered again to stimulate the economy. Being stuck in a low-rate environment robs the policymakers of a powerful tool to combat recessions, and it comes as no surprise that history won’t wait to make sure central banks are ready. Interest rates at or around zero and central bank asset purchasing programmes can keep the economy going and prevent deflation, but as the Japanese experience over the last twenty odd years have shown it can’t get the economy to grow at even a moderate pace. Furthermore, it seems self-evident that firms and households will become accustomed to cheap credit and practically no risk of increasing rates can lead to more actors taking on unhealthy debt loads. I believe that central bankers need to be bold to get us out of this pinch.
Few central bankers have been as bold as the late Paul Volcker, except of course Mario Draghi and Hayami Masaru, when Volcker in the early 1980’s drastically raised interest rates to curtail inflation. In some ways the current economic environment is if not parallel to at least reminiscent of the stagflation of the 70’s and early 80’s, except the stagflation in the 2010’s is a mix of stagnation and deflation rather than stagnation and inflation as it was in the 70’s. It’s clear to me that the strategy invented by Hayami and championed by Ben Bernanke and Mario Draghi after the Great Recession hasn’t restored growth and dispelled fears of deflation, and has made policy makers less prepared for future crises. A choice needs to be made and the way I see it there are two options.
The first option is to raise interest rates and stop asset purchasing programmes when the smoke from the Covid-19 induced recession has cleared. Restoring interest rates to a reasonable 4 % or 5 % is bound to be a painful process but it will give long term benefits to get firms to deleverage, to get financial markets to demand higher risk premiums, and to give central bankers space to use interest rates as an effective policy tool again.
The second option is to double down on low interest rates and to dare fully implement meaningfully negative rates. If 0 % or -0,5 % isn’t enough to reach inflation targets why not try to go down to -1 % or -2 % get the inflation to start rising and use that as an opportunity to normalise rates?
Both options will come with serious drawbacks but it’s worth taking a chance to get out of the stagflation of the 2010’s just as the pain of the 1980 recession was worth the pain of getting out of the stagflation of the 1970’s. The current status quo approach isn’t working and getting to grips with the erratic politics and increasing inequality of the past decade would be much more manageable if the economy was in better shape. I emphatically argue we should be more bold in our monetary policy as Volcker was to hopefully escape stagflation as he did.
If you liked this post you can read another recent post here, and read everything I've written on QE here. I'd be grateful if you shared this post with a friend or coworker who might find it interesting, and consider coming back next week for a new post!
Written by Karl Johansson
Cover Photo by Daria Shevtsova from Pexels
Комментарии