Torn between inflationary nervousness and fear of deflation, central bankers in major advanced economies are adopting a potentially costly wait-and-see approach. Only a gradual overhaul of their tools and objectives can help them play a socially useful post-pandemic role.
As the coronavirus pandemic recedes in advanced economies, their central banks increasingly resemble the proverbial donkey who, equally hungry and thirsty, succumbs to both hunger and thirst because he could not. not choose between hay and water. Torn between inflationary nervousness and fear of deflation, policymakers are taking a potentially expensive wait-and-see approach. Only a gradual overhaul of their tools and goals can help them play a socially useful post-pandemic role.
In the past, central bankers had only one political lever: interest rates. Push down to revitalize a declining economy; to curb inflation (often to the detriment of triggering a recession). Timing those moves and deciding how much to move the lever was never easy, but at least there was only one move to make: push the lever up or down. Today, the work of central bankers is twice as complicated, because, since 2009, they have two levers to manipulate.
Following the 2008 global financial crisis, a second lever became necessary, because the original one got stuck: even though it had been pushed down, pushing interest rates to zero and often forcing them into negative territory, the economy continued to stagnate. . Taking a page from the Bank of Japan, the major central banks (led by the US Federal Reserve and the Bank of England) created a second lever, known as quantitative easing (QE). Pushing it up created money to buy paper assets from commercial banks in the hope that the banks would inject the new money directly into the real economy. If inflation did appear, all they had to do was pull the leverage and cut back on asset purchases.
It was the theory. Now that inflation is in the air, central banks are nervous. Should they tighten the policy?
If they don’t, they can expect the ignominy suffered by their 1970s predecessors, who allowed inflation to become part of the price-wage dynamic. But if they follow their instincts and shift their two levers, gradually reducing QE and modestly raising interest rates, they run the risk of triggering two crises at once:, while markets and companies , addicted to free and over-extended QE money, panic at the prospect of a withdrawal. The 2013 âtaper tantrumâ that occurred after the Fed simply suggested it would put the brakes on QE would be paltry in comparison.
Central banks are afraid of this scenario because it would render their two levers useless. Even if interest rates would have increased, there would still be little leeway to reduce them. And politically prohibitive amounts of QE would be needed to revive overwhelmed financial markets. So the makers sit on their hands, imitating the hapless donkey who couldn’t determine which of its two needs was more important.
But, assuming that the two levers are to be operated sequentially and in tandem, the central bank conundrum assumes a past that does not need to be repeated. Historically, of course, the second lever, QE, was only invented after the first, interest rates, stopped working. But why suppose that with inflation rising again, the sequence must now be reversed by first eliminating QE and then raising interest rates? Why can’t the two levers be pulled simultaneously and in the same direction, involving a two-pronged monetary policy that raises interest rates and QE (albeit in a different form)?
Interest rates should indeed be raised. Let’s not forget that even in times of official zero interest rates, the bottom 50% of the income distribution is not eligible for cheap credit and ends up borrowing at usurious rates through payday loans, cards. credit and unsecured private loans. Only the rich benefit from ultra-low interest rates. As for governments, if the low official interest rates allow them to renew their debt at a lower cost, their budgetary constraints seem impossible to loosen, especially as public investment is constantly lacking. For these two reasons, 13 years of ultra-low interest rates have contributed to massive inequalities.
This growing inequality has widened the savings glut, as the ultra-rich find it difficult to spend their mountain reserve. Because flourishing savings represent the supply of money, while puny investments represent the demand for it, the result is downward pressure on the price of silver, which keeps interest rates at their lower limit. zero. Central banks must therefore have the courage to raise interest rates in order to break this vicious circle of unbearable inequalities and unnecessary stagnation.
Of course, central banks fear that rising interest rates could bankrupt governments and cause a severe recession. Therefore, rising interest rates should be supported by two crucial policy measures.
First, because serious restructuring of public and private debt is inevitable, central banks should stop trying to avoid it. Keeping interest rates below zero to prolong bankruptcy of insolvent entities (such as Greek and Italian states and a large number of zombie companies) into the future, as the European Central Bank and the Fed are currently doing , is a silly bet. Instead, let’s restructure bad debt and raise interest rates to avoid creating more bad debt.
Second, instead of ending QE, the money it produces should be diverted from commercial banks and their corporate clients (who spent most of the money on share buybacks). This money should finance a basic income and the green transition (via public investment banks such as the World Bank and the European Investment Bank). And this form of QE will not prove to be inflationary if the basic income of the upper and upper middle class is taxed more heavily, and if green investment begins to produce the energy and green goods that humanity needs.
Central banks are not forced to choose between paralysis and contraction. Progressive monetary policy would raise interest rates while investing the fruit of the money tree in climate action and reducing inequality. If that helps sell the policy, call it “lasting monetary tightening.”
Yanis Varoufakis, former Minister of Finance of Greece, is leader of the MeRA25 party and professor of economics at the University of Athens.
Copyright: Project Syndicate