The persistence of negative interest rates in Europe and the low interest rates in the United States challenges many of our economic assumptions. We have depended on monetary stimulus to push full employment and economic stimulation as a remedy for recessions and slow growth periods. We also depend of fiscal stimulus in the form of lower taxes and less regulation.
There are other factors that we probably underestimate. The political controversy and partisan differences do little to assure whatever changes are enacted will stand long enough before a change in political power reverses the change. Hillary Clinton criticized the short term thinking of businesses, but the short term and erratic behavior of fiscal policy makes long term planning very risky.
Marginal projects are tabled and only the larger returns justify the extra risk. Successes are larger, increasing inequality.
If interest rates are the price of money what do ultra-low and negative interest rates tell us?
- There is way too much money chasing too few viable opportunities. Much of the debt is used to fund the record deficits and debt and there seems to be an insatiable demand for that, but government debt is different from market debt. It is possible that the large portion of government debt is a reason that this easy credit has not been inflationary.
- Lower taxes allow companies to self-fund their growth, reducing their need for debt financing. The amount of the tax savings spent on share buy backs indicates that they have more money that they have growth-oriented projects to pursue. Buybacks are part of the reallocation process, passing from a company with few opportunities to companies with greater promise. Part of this pressure is the shareholder value incentives for management, incentivizing them to make larger bonuses by manipulating share value than improving productivity and profit (a practice we should discourage).
- There is a mismatch between countries with stable financial structures and countries with great growth opportunities. Emerging nations have more room to grow but business owners in third world and some second world countries prefer to hold their cash in more stable economies increasing the supply of cash.
- This also indicates that first world countries with stable financial systems have less growth either from excessive regulation and the cost of their welfare states, or a cultural shift that is reducing their entrepreneurial drive.
- There is also a cultural shift on the demand side that resists Keynesian consumer stimulus. Like uncertainty in production the constant vacillation of policy leaves consumers less likely to make large purchases.
If interest rates are near zero or below, what other tricks do the central banks have? They are no longer able to bail out the government from its undisciplined fiscal policy. The fragility in the economy is exhibited when the slightest increase in interest rates in an economy with modest strength and record low unemployment sends the equity markets plunging.
Political and economic policy have been joined at the hip for a century and the political uncertainty greatly affects investment decisions and certainly does not encourage long term thinking.
Economics is still a new school of thought and every tumultuous period disproves prior assumptions. Central control of the economy is most elusive when the economy is having major transitions like we are now experiencing.