In the US, currently, inflation is very low (atleast as per the official data) and has remained and is expected to remain low for a considerable amount of time. And so some, like the Federal Reserve Bank of Minneapolis president Narayana Kocherlakota, have called for further easing of monetary stimulus. They even argue for a negative interest rate in the US, meaning, pushing the federal funds rate below the 0% bound (check this link). And with all due respect, I have to disagree with this proposal.
First of all, let’s take a look at the global economy today. The United States’ economy, in all parameters, has considerably rebounded from the recession era lows (not just the stock market – which has had a massive bull run for the past 6 years - but the real mainstream economy itself, has rebounded nicely). In the last two years especially, the job market has been relatively healthy and quite resilient. Consumer spending has grown. Consumer confidence in the economy has grown. Services industry has grown. Manufacturing rebounded nicely last year, but has been quite badly hit this year (due to a stronger dollar and weak global growth – and I will get to it in a minute). All this happened at a zero bound interest rate setting. But was that the only factor that spurred growth? Absolutely not!
As much as the monetary stimulus was effective, an equally important factor for the growth in the last 6 years was China. China’s fiscal stimulus was a boon to a large part of the world. Countries from Australia to Brazil, Thailand to South Africa, Japan to Russia, Indonesia to Switzerland and many more profited from the immense investments that took place in China. These investments not only contributed to higher commodity prices – which made nations like Saudi Arabia immensely rich in forex reserves – but also increased the sheer number of Chinese middle class consumers – whose purchasing power was a boon to many - like the Swiss watch makers and German car makers. So the global economy itself largely benefited from these investments in China, and that had a positive effect on the United States as well. Along with all these positives, a lot of mistakes were done (in terms of quality, size and credit) in these investments in China – for which China is paying a price now. And not just China, the world itself is paying a price now – not because China overdid things, but rather because the world under-did things. In other words, the major factor that is holding back global growth today is a lack of capital investments globally. What China overdid, was underdone by the rest of the nations.
Now this gets us back to the negative interest rate. Do we need it? In my opinion, no! – because the root of this problem goes back to a sudden slowdown in the Chinese economy. Naturally, the Chinese economy overheated and is going through a cooling phase. And along with it, all the nations that benefited from the Chinese super-growth story are going through the slowdown as well. During this phase, China is also, rightly, going through a transformation to shift its economy’s over-reliance on manufacturing, export and investment-led model to a decent reliance on consumer-driven, more services and innovation-based model. But this will take time. As a close observer of global finance, I have no doubt in my mind that China will ultimately be successful in this transition. But I have also no doubt in my mind that China will make a lot of mistakes during this transition phase – mainly due to their inexperience, and not necessarily inability, in managing such a heavy transition in such a massive economy.
A negative interest rate in US will do nothing more than provide a cushion, to a certain extent only, for currency instability in China and other emerging markets. But barring that small advantage, the negative interest rate will only lift up asset prices globally – which again goes to this thinking of monetary strategists that – if asset prices go up, consumers will feel more confident to spend and this in itself will provide a boost to the economy. But what kind of boost is that? A boost given by artificial demand! I call it “artificial” because the consumers will be forced to make use of their money even when they would have preferred to save. Such a strategy severely distorts the global supply & demand, investments, free markets and asset prices. We followed such a strategy at the depth of the global recession – as a temporary and a priority measure to reboot the economy and create sufficient demand. But we are well past that phase now. Repeating that again and again will only set us up for a long term pain through distorted capital flows and more recessions or setbacks.
Money is still cheap. That is not the problem here. It’s the application of money that is the problem. Where do we apply the cheap money available? Can we start with worker training /skill training programs? Or can we start with more affordable housing for the poor that would reduce their rent burden? Can we start with putting more money in the hands of families with children that will reduce their child care costs? Or can we resolve the immigration problem that will help lift business investments and thereby demand? Can we start with reducing the health care costs of middle-income and poor families by transferring some of the wasteful agricultural subsidies into the health care and medical research sectors? Or at the very least, can we employ the thousands of unemployed without a college degree by repairing and improving the transportation and sanitation infrastructure?
It all boils down to two words – “capital investments” or "fiscal stimulus" – not just in US, but also in countries like India, Indonesia, nations in Africa etc. (especially by commodity importing countries - now that commodity prices are so cheap). That is the right kind of stimulus needed now, not negative interest rates, to push the global economic growth to a higher and more sustainable trajectory.