Clueless central banks

U.S. Federal Reserve Chair Janet Yellen
U.S. Federal Reserve Chair Janet Yellen is one of many central bankers who have implemented policies that could make the next global downturn even worse (source: dpa)

What if the current cycle of economic growth comes to an end sooner than expected? The question might come as a surprise. What growth cycle? When should it end? What does that mean for global economics?

Since the end of the financial crisis seven years ago, the world economy has been continuously expanding. Granted, the pace of global GDP growth has not been the 6 percent that many textbooks stipulate should be the norm, but it has been steady at more than 4 percent per year. If business-cycle theory is any good, then this period of growth will eventually near its end.

Some signs that it will happen sooner rather than later are already apparent. Global economic growth fell to 2.9 percent in mid-2016. Global productivity and investment are slowing down too – dramatically, in the case of productivity. To be sure, none of this means that a recession is inevitable. But signs usually associated with a changing of the cycle are there.

The biggest question is how monetary policy will react to this cycle. Currently, central banks all over the world are practicing adjective economics. Just recently, the U.S. Fed has moved from what some analysts term an ultra-accommodative monetary policy to one that is merely moderately accommodative.

Central banks have been trying to stimulate the global economy for the whole duration of the current growth cycle – apparently without much success. Despite quantitative easing, forward-guidance and negative interest rates, global GDP growth has not taken off.

Avoiding the business cycle should not be the priority of central banks or governments


Some economists, almost by reflex, have called for more fiscal spending to either boost growth or reduce the risk of a downturn. They nearly all seem to understand lax fiscal policy as complementary to adjective-driven monetary policy. They are wrong.

The current monetary policies are not working because they create severe microeconomic imbalances. Interest rates are the price of money. If money is too cheap, or even free, investors will withhold investment out of suspicion or invest without regard to productivity. The results – either low investment levels or low productivity growth – lead directly to recession.

When governments spend lavishly, the benefits can only be transmitted to the real economy if the microeconomic conveyor belt works. That requires capital to be productive. But if capital has no price, it cannot be used productively.

Avoiding the business cycle should not be the priority of central banks or governments. Creating conditions that allow businesses and individuals to deal with the cycle, should. Among such conditions are the proper, risk-related price of capital (a higher interest rate), the alignment of risk and agent (central banks not buying state or private debt) and allowing the future to reflect individual risk-reward calculations (no forward guidance).

If the current growth cycle comes to an end, it will not be central banks that come to the rescue. In fact, their monetary policies make the recessionary tendencies worse. The only conclusion is that they are economically clueless.

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