White: ‘Burden of Debt’ Will Slow Global Growth

Bill White, formerly of the BIS and now with the OECD spoke to Bloomberg News during the KC Fed’s annual meeting in Jackson Hole, WY. He gave some rather pointed answers to questions about the Federal Reserve’s monetary policy.

I reviewed some of White’s remarks in my April piece The origins of the next crisis regarding the global economy and the accumulation of debt in advanced economies. The remarks he made to Bloomberg were of the same nature. In particular, White characterized the medium-term to longer-term problem in language I used a couple of days ago in Why the U.S. economy is weak, regarding the centrality of household debt.

The question for the Fed is: what should a central bank do to deal with a weak but indebted economy. White says that the Fed shouldn’t leave interest rates too low for too long. He says:

Clearly there are advantages to keeping interest rates low. We know what the rationale is. It’s an attempt to try to encourage more demand — and one would hope in particular more investment demand that might contribute to the expansion of tradable goods, etc. So, all of that is good and I don’t deny it.

The point, however, that I would make is that there is another side to very, very easy money which is over a longer horizon – okay, not tomorrow, but over a longer horizon – very low interest rates are bound to generate lower savings than you would otherwise have which is not a good thing. It allows people to borrow money to keep themselves alive – soft of an evergreening of high risk companies through the bond markets. It encourages zombie companies and zombie banks, misallocations of resources.

Now, all of these things are medium-term things and Chairman Bernanke has a clear and pressing present problem. And this I don’t deny. My only point would be that we evaluate what to do going forward, that the framework should encompass both the short-run effects of monetary policy and the medium-term effects.

So, loose monetary policy does help to increase demand. However, over the medium term, loose monetary policy lowers household savings rates and encourages the accumulation of debt and the zombiefication of industry. So, over the medium-term an ultra-low rate policy is toxic. This has certainly been the experience in Japan – and I suspect it will be no different in the US.

Higher rates now would probably help tip the U.S. back into recession. However, over the medium-term, the zero interest rate policy cannot persist as it has done in Japan. My feeling is that we are in a policy cul-de-sac right now. The "Doom Loop" of ever lower rates and ever rising household sector debt burdens and ever rising financial service leverage is at an end and that leaves little which monetary policy can do despite Chairman Bernanke’s assurances.

  1. Tom Hickey says

    MMT’ers have consistently held that monetary policy would prove ineffective, especially in a liquidity trap, and that a fiscal solution is required.

    See Bill Mitchell commenting on Richard Koo.

    Balance sheet recessions and democracy

    Along with this fiscal approach based on sectoral balances, the US and world need real financial reform that 1) closes the output gap and reduces unemployment and the huge losses from foregone opportunity and degraded resources, 4) resolves the debt overhang that is creating a drag, 3) addresses the massive “control fraud” documented by Bill Black, Frank Partnoy, Janet Tavakoli, Elliot Spitzer, and others, and 4) returns financial capitalism to the service of productive capitalism instead of parasitic rent-seeking, as articulated by Michael Hudson, for example.

    Fiddling with monetary policy will do nothing material to address the underlying issues.

  2. Ralph Musgrave says

    I fully agree with Edward Harrison’s claim that leaving interest rates too low too long leads to a misallocation of resources. But I don’t think that puts it strongly enough. I think that fiddling with interest rates should basically NOT be used to regulate economies, other than perhaps occasionally and in emergencies. My reasons are on my blog here:


    1. Edward Harrison says

      Ralph, I know that Randy Wray who is a leading scholar of MMT believes as you and I do that having the Fed fine tune the economy via interest rates doesn’t work. I would prefer the market set the rate and the Fed act as a lender of last resort. Wray believes we should set fed funds at a low rate in perpetuity and forget about it. But again, just leaving rates at a fixed level in perpetuity can introduce the misallocation problem as well.

      1. Ralph Musgrave says

        Edward: certainly the phrase “the natural rate of interest is zero” is a popular on in MMT circles. But to say that MMT supporters advocate low interest rates in general is questionable. My reasons for saying that are complicated. But briefly, MMT claims that the inter bank rate should be zero or will always tend to zero. But that is quite separate (or OUGHT to be separate) from the rates involved where say Exxon issues bonds or a household gets a mortgage.

        Unfortunately (in my view) these two rates are connected because we allow maturity transformation. I.e. there IS a misallocation of resources here, but it results from allowing maturity transformation, not from the fact that inter bank rates, or rates for short term deposits are zero or near zero.

        I’ve just plonked some thoughts on this here, which might clarify the above points:


        1. Edward Harrison says

          Maturity transformation is an integral part of banking and is going to be here to stay. I don’t know how you get rid of that, Ralph.

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