Last Friday, at our Monetary Policy Forum (MPF) event hosted in partnership with Refinitiv, we called for the advanced economies to shift decisively to a higher yield environment. Ten years before, in the throes of the most severe global financial crisis for 80 years, Fathom used our first MPF to argue strongly in favour of unconventional monetary policy, such as quantitative easing (QE). A decade on, in the final quarterly MPF, we called for these policies to be reversed in order to escape the low growth, low interest rate environment that the advanced economies remain stuck in. We were joined by former MPC members Sir Charlie Bean, Rachel Lomax and Andrew Sentance.
The event began with a Fathom presentation on economic developments in the advanced economies since the advent of independent central banking in the UK 21 years ago. At first, everything went to plan. In the ten years from 1997 to 2007 average inflation in the G7 was lower than in the decade before, averaging around 2%, with much lower volatility. As had been expected, low and stable inflation was associated with other positive economic outcomes. There seemed to be no trade-off with GDP growth, which remained broadly unchanged, however, with much lower variance.
The Global Financial Crisis, and economic developments since then have raised big questions about this previously accepted policy mix. While independent central banks have broadly met their inflation targets, it has come at the cost of severely negative side effects including financial imbalances and dire productivity growth. Economic growth in the ten years to 2017 was both weaker than in decades prior and much more volatile, too. That alone would be enough to occupy the minds of policymakers for some time. But cyclical risks look set to make things even more challenging.
We expect a US-led global recession in two years for reasons that we have previously outlined. Indeed, our proprietary model shows that the implied probability of a US recession will rise to a record high by the end of next year. When the next recession arrives, policymakers will find themselves with few tools in the cupboard to deal with it. During an average recession, central banks cut the policy rate by 370 basis points. However, outside of the US, interest rates are at the effective lower bound, nullifying the first line of counter-cyclical stimulus.
Even without a recession, the advanced economies were facing the prospect of a permanent bad equilibrium: high debt, low interest rates and low productivity growth. Total debt in the advanced economies now makes up a record 190% of GDP, up sharply since before the financial crisis. The weight of that debt prevents interest rates from rising, with malign economic side effects. Fathom’s long-held view is that low interest rates harm the supply side of the economy, leading to lower productivity growth rates than would otherwise be the case. The current inflation-targeting framework is not equipped to help us escape this poor outcome.
We invited our panellists to give their assessment of the Fathom view. Sir Charlie Bean acknowledged the large number of potential downside risks to the global economy, but said that he felt that the policy cupboard was less bare than Fathom made out. For one, he said it was still possible to ramp up stimulus via QE. In his view, the scope of central banks to purchase assets remained very far from its theoretical limit, as they could buy unconventional assets such as expensive art and housing. More likely, in his view, was that central banks could find alternative methods to reduce the real rate of interest.
Andrew Sentance spoke next. He began by noting how no one on the Monetary Policy Committee in 2009 expected interest rates to remain this low for this long. Mr Sentance agreed that low interest rates may now be having a negative impact on economic growth. He was skeptical about the ability of economists to forecast a recession in 2020, but accepted that there was likely to be one at some point in the coming years. However, he was of the view that protectionism or a technology-related shock were more likely catalysts.
Rachel Lomax was the final one of our panellists to respond. She noted the incredible persistence of the current monetary policy framework, contrasting it with her experience in the 1980s when it would change from one year to the next. Nonetheless, she felt that central bank independence had become siloed and said that recent editions of the Inflation Report and Financial Stability Report appeared extremely similar to those that she had produced some years prior.
As usual, we closed the event by inviting our audience to express their own views on the macroeconomic and financial market outlook. We started by asking our invited guests when they thought the major economies would next suffer a recession. Well over half opted for either 2019 or 2020, with the plurality in agreement with Fathom that 2020 was the most likely year. Around one quarter believed there would be no recession before 2022.
Only 20% of our audience felt that the major economies would return to pre-crisis rates of productivity in growth within the next ten years with no government intervention. Around a third felt the advanced economies would return to previous rates of productivity growth within the next decade, but only once interest rates reached pre-crisis levels. The remainder (46%), felt that the advanced economies were stuck in a low interest rate, low growth environment, and that there was nothing that could be done about it.
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