Members of the Treasury select committee get the chance to grill the governor of the Bank of England on Tuesday. Mark Carney will make the short journey from Threadneedle Street to Westminster to face questions on the state of the economy. It should be an intriguing contest. The committee’s chairman, Andrew Tyrie, will treat the governor with the weary disdain of a headteacher ticking off a pupil for a substandard piece of homework. Carney will answer in sentences so long that MPs may feel the need for a drinks’ interval half way through them.
Tyrie deserves to be cheered on, because central banks have had it far too cushy for far too long. It is taken as read that the best way to run an economy is to muscle politicians out of the way and let technocrats run things.
When the financial crisis turned nasty in 2008, central banks were at the zenith of their influence and were handed the responsibility for cleaning up the mess. They slashed interest rates and pumped up the money supply through the use of quantitative easing, the process whereby a central bank buys bonds and exchanges them for new electronic money.
Economic policy quickly became lopsided. For a brief period, fiscal policy was used to cut taxes and increase public spending but the general approach since the crisis has been for monetary policy to remain ultra loose and for budgets to be kept tight. Governments have relied on low interest rates and QE to generate enough growth to offset the impact of raising taxes and cutting public spending.
The strategy prevented a second Great Depression but has not delivered a strong and durable recovery. Interest rates were supposed to stay at emergency levels for only as long as it took to return life to normal. In the UK, these emergency levels have now lasted for longer than it took for the Beatles to record every one of their albums.
There seems not the remotest chance of emergency rates ending any time soon. January 2016 was the month when inflation was supposed to shoot up in the UK, because the big 0.9% monthly drop in prices seen in January 2015 then dropped out of the year-on-year calculation of the cost of living. In fact, there was only a small 0.1 point increase in inflation to 0.3% because the price fall in January 2016 of 0.8% was almost identical to that in January 2016.
What’s more, the annual inflation rate will fall over the coming months unless last year’s monthly increases in prices – of either 0.3% or 0.2% – for each month between February and May are repeated.
It’s the same story everywhere of weird policy becoming even weirder. Seven and a half years after the collapse of Lehman Brothers the US Federal Reserve has tried raising rates and is already regretting it. The City half expects the next move in UK interest rates to be down. Elsewhere interest rates are negative, with commercial banks being penalised for depositing cash with central banks in the hope that they will instead use their funds to lend to the private sector. What started in some of the smaller countries – Switzerland and Sweden – has now spread to the big boys. Both the European Central Bank and the Bank of Japan now have negative rates.
Growth is tepid, productivity is poor, and inflation is too low for comfort. The Organisation for Economic Cooperation and Development last week joined the International Monetary Fund and the World Bank in cutting its growth forecasts for 2016. Another recession now would send the global economy spiralling into deflation and put the eurozone under immense, and perhaps terminal, strain. Clearly, all is not quite going according to the masterplan drawn up by central banks.
As far as the OECD is concerned, monetary policy is being forced to take too much of the strain. Its chief economist Catherine Mann made the point that lasting recovery required three things: stimulative monetary policy; activist fiscal policy; and structural reform. The OECD wants the second of these ingredients to be added to the recipe in the form of increased spending on public infrastructure, something it says would more than pay for itself at a time when governments can borrow so cheaply.
The Paris-based thinktank says collective action by the world’s leading economies is needed because a go-it-alone approach will result in the effects of stronger demand being blunted by higher imports. It will make the case for higher investment spending at this week’s meeting of the G20 in Shanghai, almost certainly to little effect. Central banks will argue that they still have plenty of ammunition left, even though as the years tick by it becomes more and more apparent that relying solely on monetary policy is the equivalent of pushing on a piece of string.
Central banks now have one last chance to live up to their exalted reputations. A prolonged period of low but positive interest rates carries the risk that it will create the conditions for asset price bubbles. That risk is amplified by quantitative easing.
All the dangers associated with low but positive borrowing costs apply to negative interest rates – but with some added complications. One is that it affects the profitability of banks, by squeezing lending spreads, at a time when many of them have yet to make a full recovery from the last crisis. Another is that central banks will overcook things and that the deeper into negative territory interest rates go now the higher they will have to go later.
Perhaps though the biggest danger is to the reputation of central banks. Throughout the crisis, the assumption has been that the Federal Reserve, the Bank of England, the European Central Bank, the Bank of Japan and all the other central banks are in control of a tricky situation. Central bankers give the impression that they can model the impact of interest rates and QE on growth and inflation; that is part of their mystique.
Now, it may be that it is simply taking time for central banks to get to grips with a protracted and complex crisis. Everything may work out well in the end, with inflation returning to target and interest rates back to more normal levels. The absence of supportive fiscal policy could be making an already tough job that much tougher.
But the longer this goes on the more the suspicion grows that central bankers aren’t quite so clever as they think they are, and that what is dressed up as a carefully calibrated policy response is really just blundering around in the dark. Central banks have been conducting a gigantic experiment over the past seven years and Tyrie will want to know from Carney whether he actually knows what he is doing. It is a perfectly fair question.
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