If you haven’t seen Douglas Carswell’s brilliant essay for UnHerd, then do yourself a favour and read it here. Entitled ‘Blame central bankers and their easy money for our troubled economic times’, it does just that – showing how ultra-low interest rates work to the benefit of the underserving rich and the detriment of almost everyone else.
However, his analysis does beg a rather big question: if easy money is so damaging then how have those responsible — first and foremost, the central bankers — got away with it for so long?
Actually, this is two questions:
- how have they got away with it politically; and
- how have they got away with it economically.
Firstly, the politics. Douglas Carswell is against independent central banks on principle. Monetary policy decisions should be a matter for democratically elected politicians, not appointed technocrats that can’t be voted out. Fair enough. However, in respect to easy money let’s not kid ourselves that this is something our politicians would have done any differently. Indeed, they’ve actively done their bit to pump cheap debt into the economy – for instance, by loosening the regulatory framework (until the resulting financial crisis). And I’m afraid that we, the people, haven’t exactly been out on the streets demanding a return to monetary and fiscal discipline. We like cheap debt, we like low taxes, we like high spending.
Of course, you can’t have low taxes and high spending without lots of borrowing. The deeper that a nation goes into debt, the greater the pressure to keep interest low enough to keep the cost of servicing and refinancing that debt within affordable bounds. With enough pressure, monetary policy (i.e. the setting of interest rates) becomes subservient to fiscal policy (i.e. financing budget deficits). This state of affairs is known as fiscal dominance and it is generally reckoned to be a bad thing. Writing for City Journal, the economist Bill Watkins explains why:
“For years, fiscal dominance existed on the fringes of economics, important mostly to economists thinking about fiscally irresponsible countries such as Argentina and Brazil. Italy, too, has a long record of monetary accommodation of deficit spending. There’s a reason none of these countries has achieved its economic potential—fiscal dominance has led to bad outcomes, including ever-increasing inflation, reduced trade, declining consumption, and, eventually, political instability.”
Keeping a lid on inflation (and everything that stems from it) is, in normal circumstances, the top priority of monetary policy and thus the setting of interest rates. Fiscal dominance typically distorts the order of priorities, dragging interest rates below the level needed to contain the inflationary beast. Because voters like low prices even more than low taxes and high spending, they tend to punish governments that let inflation rip.
In previous decades, ultra-low interest rates would have resulted in ultra-high inflation; but in recent years, they haven’t. Which brings us to our second question. The main reason why the central bankers have gotten away with things economically is that they’ve been operating in a disinflationary environment. Indeed, in some countries – such as Japan – the primary threat is outright deflation (i.e. negative inflation).
If inflation isn’t a threat (or at least a much smaller one than it used to be) then some might ask whether fiscal dominance matters any more. Needless to say, it does matter, because, as Douglas Carswell explains in his article, rock bottom interest rate policy (and its scuzzy mate, quantitative easing) can wreak havoc in many other ways.
Perhaps the most fundamental question is why the money markets put up with such low interest rates. After all, the rates set by central bankers act as a floor on market rates, not a ceiling. Commercial lenders have every incentive to loan money at the highest rate that borrowers are willing to pay. Like all prices in a free market this is subject to supply and demand. Therefore if interest rates are so low it is because there is too much money on offer to borrowers who have too little use for it (other than overheating the housing market).
If western economies were bursting with exciting opportunities in productivity-boosting enterprises, then the competition for investment capital would be more intense and interest rates would be higher. The fact that rates have been so low for so long is a sign not just of bad policy, but also of a failing economic system.