The Bank of England is turning into a hotbed of intrigue.
On the one hand, governor Mark Carney is utterly certain that interest rates shouldn’t go up. Brexit will hurt. Until the economy has got used to that, rates should stay low, pretty much regardless of what happens to inflation.
On the other, three members of the Bank’s Monetary Policy Committee (MPC) voted to raise rates this month. And Bank chief economist Andy Haldane said that he’s starting to think it might be a good idea too.
So it was particularly interesting to see departing MPC member Kristin Forbes (one of the so-called ‘hawks’) come out with a punchy farewell speech in which she asked why central banks are having such difficulty letting go of zero.
Her conclusions make me think she’d be a great candidate for governor…
A series of unfortunate events? Or a self-inflicted injury?
Kristin Forbes asked some pretty searching questions in her departing speech from the Bank of England. Why are interest rates around the world still near zero, nearly nine years on from the peak of the financial crisis? Why are we still at emergency levels even although global economic growth has been pretty solid?
More to the point, why are central banks stalling on raising rates despite history showing that “interest rates at such low levels, especially for a prolonged period of time, can increase risks – such as fostering financial market bubbles and unsustainable borrowing, supporting an inefficient allocation of resources, and creating challenges for pension funds, savers and banks?”
Forbes goes through all the widely argued reasons for rates staying as low as they are. One is the sheer scale of the crisis and the scars it left behind. Another is the idea that interest rates should be permanently lower than they once were, partly because of worsening demographics (this is the “secular stagnation” theory).
A third is that we’ve suffered “a series of unfortunate events” – every time the world looks like embarking on a strong recovery, something random (“exogenous”) happens to knock it back down on its backside. For example, the epic oil price crash from mid-2014 saw headline inflation figures slump, meaning there was less pressure to raise rates.
Equally, “in the few windows when… risks appeared to be easing, there inevitably seemed to be some major election, political event, or debt negotiation that was generating heightened volatility in financial markets and that could potentially undermine the broader recovery.”
There’s “some merit” to all of these explanations, she notes. However, it’s not the full story. Regardless of how mediocre the economic recovery has been, the UK is now “stronger than when past ‘launches’ to higher interest rates occurred”. Indeed, based on history, the UK looks even better placed to cope with higher interest rates than the US is.
So what’s holding central banks back from abandoning emergency measures?
Politics, central banking and moral hazard
The answer’s simple, says Forbes: politics.
Forbes makes a few points about how much more complicated life has become for a central banker. She notes that the Bank of England has been handed lots of new powers – the ability to tighten mortgage requirements, for example – that might take some urgency out of the need to raise interest rates.
Less charitably, you could argue that central banks have become a dumping ground for all the things that governments don’t want to take direct responsibility for.
This also leaves less time for the staff involved to focus on setting monetary policy. With everyone a lot more busy, it becomes a lot easier for groupthink to set in because individuals have less time to think analytically.
But she also flags up just how much more public a role that of central banker has become. And she highlights one man in particular – MoneyWeek’s favourite trickster deity, Alan Greenspan.
With a nod to Sebastian Mallaby’s recent Greenspan biography, she notes that “Greenspan might have been more proactive in addressing vulnerabilities that contributed to the global financial crisis if he had been less concerned about his political popularity.”
When Greenspan’s predecessor Paul Volcker raised interest rates in the early 1980s, for example, he faced serious abuse. (Apparently farmers blockaded the Fed’s headquarters with their tractors at one point). “Can you imagine a central banker today facing that type of ire?” she asks.
Forbes is very tactful about it. But ultimately she’s arguing that, as human beings, central bankers are apt to take the path of least resistance, particularly in light of all of the extra responsibility they have today. And the path of least resistance is extremely clear.
If you’re worried that raising interest rates will cause pain (and how can it not in today’s environment?), might you not be tempted to leave the problem for another day? “Put slightly differently,” says Forbes, “do central bankers today put more weight on how tighter monetary policy could affect unemployment during their term and less on the costs of low interest rates in the future?”
She points out that even in her short three-year period as a central banker, the Bank has been much quicker to react to potential downside risks, than to signs of economic strength (the post-Brexit panic being the obvious example).
In other words, the system is riddled with moral hazard. Central bankers don’t want to raise rates because they don’t want the short-term pain, and everyone else is happy to let that continue too.
And the truth is that, while Volcker did make some tough decisions, he was between a rock and a hard place. He had no easy options. Inflation was in double-digits, the dollar was cratering and the economic outlook was grim either way.
You have to wonder if it’ll take a similar situation to push today’s central bankers to act as well.
Tomorrow, I’ll take a look at how zero interest rates have hit savers and investors, and what that might mean in the longer run.