Central banks are still keeping interest rates at rock bottom. When the 2007-8 financial crisis struck, reducing interest rates was the classic response. And it worked: the inevitable slide into recession was controlled. But eight years later the policy is no longer doing any good. On the contrary, it is causing great harm. It needs to be reversed.
When a central bank continues its policy of low interest rates long after the emergency that prompted them has passed, it automatically sends a signal that all is not well: inflation may not be a problem, but ‘there is trouble ahead’. So, not unnaturally, both-individuals and companies restrain spending and draw in their horns.
If a person is saving for retirement or to repay debt, but their savings are-yielding almost nothing, they have to save more and spend less. And companies, fearing less demand from customers, restrict investment for future expansion.
A particularly serious problem faces companies with defined-benefit pension funds, of which there are thousands. With the income from bonds reduced, the amount of-capital a pension fund needs to fulfil its obligations rises. The ‘value’ of the pension fund’s-liabilities grows, and a deficit emerges. Often the deficit grows alarmingly. So the sponsoring company has to contribute more to the fund, leaving less for investment in its business and for dividends to shareholders.
This bears down on capital investment programmes which companies might otherwise embark on. Thus, low interest rates tend to suppress both investment and consumption, and the productive economy is kept subdued. Moreover, since people no longer fear inflation, they may think prices will fall and so postpone purchases, further slowing things down.
What this reveals is that people may not respond as economists predict. US Federal Reserve chair Janet Yellen made a speech at bank’s annual summit in Jackson Hole in late August explaining with flawless logic how central banks work to prevent recessions, and why low interest rates are the right-policy when crisis strikes. However, she did not mention a time limit.
Furthermore, there is a revolution going on which she did not mention either. Indeed it is proceeding apparently unnoticed. The internet revolution has made it possible to maintain the same standard of living with less monetary outlay. Buying goods or services online costs less. The web releases competitive forces which keep prices down. There are countless examples: travel (Uber), accommodation (Airbnb) and many different forms of digital communication all demonstrate this. Indeed almost all services and goods are exposed to competitive forces that reduce not only prices but also the use of-resources. This changes everything. The effect is fundamental; and an incidental result is that the low-interest-rate policy of central banks may be aiming to restore an old economy which will never return.
Unfortunately, low interest rates, which currently prevail in all developed economies, do not lead to renewed prosperity. And the policy is also profoundly worrying-politically. For low interest rates mean that capital assets such as real property, including houses and equity investments, automatically go up in value; so the minority who have such assets reap a gain without effort or skill, at the expense of the vast majority.
This is highly divisive; it looks like-people at the top looking after themselves at the expense of everyone else. It leads voters to reject the views of those in authority, and it drives people towards extremes. These trends are visible everywhere.
It should seem obvious by now that the low-interest-rate policy is not working. Does anyone really think that reducing the bank rate from a half to a quarter per cent is going to make any positive difference? And yet central banks persist. Any would-be scientist knows that if an experiment on given facts yields an undesired result twice, it is pointless trying a third time. Instead of persisting with a policy that is not effective, central banks should give a clear message of a return to normality.
The central banks of the US, the eurozone, Japan, Canada and the UK should agree to raise rates by enough to signal a real change — and this needs to be done-simultaneously so as to eliminate the risk of an attempt to achieve competitive devaluation by delay.
The message would be clear. Confidence would return. People would start to spend. Companies would invest. It would be worth saving once more, thereby generating-capital for investment in the future. Prosperity would beckon once more.
Sir Martin Jacomb is a former chairman of Prudential and Canary Wharf Group, deputy chairman of Barclays and director of the Bank of England.