William R. White is the chairman of the Economic and Development Review Committee at the OECD in Paris. Prior to that, Dr. White held a number of senior positions with the Bank for International Settlements (“BIS”), including Head of the Monetary and Economic Department, where he had overall responsibility for the department's output of research, data and information services, and was a member of the Executive Committee which manages the BIS. He retired from the BIS on 30 June 2008.
Dr. White began his professional career at the Bank of England, where he was an economist from 1969 to 1972. Subsequently he spent 22 years with the Bank of Canada. In addition to his many publications, he speaks regularly to a wide range of audiences on topics related to monetary and financial stability.
In the following interview he shares his views in a totally personal capacity on the current state of the global economy and related monetary and fiscal policies.
E. Tavares: Dr. White, we are delighted to be speaking with you today. You are recognized as one of the leading central bank economists in the world, and so your perspective is highly valued and appreciated.
Absent the robust central bank intervention in 2008 the world’s financial system would have likely collapsed. However, in a sense the economy looks riskier now: government debt levels as a function of GDP are at record highs; big financial institutions have gotten even bigger; and while we may not have a housing credit crisis brewing in the US, we are seeing stress in many areas, from student loans to energy bank loans to emerging market convulsions. At the same time, income inequality has blown out of proportion as booming asset prices hardly benefited the less privileged in society.
With the benefit of hindsight, can we say that the very loose monetary policy of central banks around the world lulled politicians and investors into a false sense of security and that those unresolved issues from the recent past could still come back to haunt them? Or can they keep things under control with these newly found monetary “bazookas”?
W. White: I think your assessment of where we are at is spot on. What the central banks did in 2008 was totally appropriate. The markets were basically collapsing. We had a kind of a “Minsky moment” problem with market illiquidity and the central banks did what they had to do.
Since then the focus has changed. I believe that it was in 2010 when Ben Bernanke, then Chairman of the US Federal Reserve, made clear in a speech that the objective of monetary policy – and specifically quantitative easing – was basically to stimulate aggregate demand. And since then we have had all the central banks around the world pursuing that objective through increasingly unconventional measures.
However, there is a fundamental shortcoming in using monetary policy in this way. Just as you described it, the fundamental problem we all face is a problem of too much debt, you know, the headwinds of debt. In a sense it is a problem of insolvency. And relying on central banks to correct this is totally inappropriate, because they can handle problems of illiquidity but they can’t handle problems of insolvency. So I think that the fundamental orientation here is wrong.
Now, why is this happening? In part, I think, it’s because dealing with problems of insolvency, debt reduction, making debt service more bearable and so forth, demands policies that only governments can implement. Moreover, these policies are likely to be technically hard to implement and will also meet stiff political resistance. You know there’s this old line from Daniel Kahneman: we have to believe – we are hardwired to believe – and so since we must believe then it’s just as well to believe in something convenient. And I think the politicians find it convenient to believe that the central banks have it all under control.
But it’s not true, because what we have been doing is both losing efficacy over time, that is to say that the efficiency of the transmission mechanism seems to me to be getting less and less, while the impact of the associated unintended consequences, the side effects of monetary policy, are becoming more and more evident. In the end this is really going to cause us problems.
And of all the unintended consequences I could list, lulling the governments into a false sense of security is probably the most important.
ET: In a modern financial economy, liquidity is created primarily by the banks through credit creation. When that liquidity creation slows down typically the economy falters. So as the banks were forced to deal with credit and balance sheet issues from 2008 onwards, the central banks stepped into that role by cheapening the cost of credit and conducting large scale asset purchases to make sure that liquidity continued to flow throughout the economy.
However, even that seems insufficient to rekindle economic growth, prompting some central banks to go a step further and adopt negative interest rates (“NIRP”). Japan is the latest convert. Is that the likely next step for other central banks, including the Fed?
WW: I think it is entirely possible. But before I get into that I would like to comment first on the efficacy of monetary policy as you briefly outlined. The whole thing is premised firstly on the idea that easy money will stimulate demand, and secondly that the unintended consequences are nothing to worry about.
On that first issue, I have very serious doubts whether the very easy money policies will have the impact that central bankers believe it should have. And after seven years of the slowest recovery ever, it seems to me that there is empirical support for that proposition.
Now why do I think it won’t work? I think what they’ve done, particularly the unconventional stuff – and there has been so much of it, including forward guidance, quantitative easing, qualitative easing and now NIRP – has led many people into looking upon all of this as experimental policies smacking of panic. And, as a result of the associated uncertainty, they may have hunkered down instead of going out and spending the money.
There’s another point which is closely related. Think about interest rates being brought down to very low levels. The whole point is trying to attract spending from the future into today, what is known as intertemporal reallocation. That is just fine. But if you’re bringing that spending forward, at a certain point when tomorrow becomes today – as indeed it must inevitably do – then that future spending that you might otherwise have done is constrained by the spending that you have already done. And that manifests itself in increasing debt levels, which indeed we have already seen.
So, almost by definition, monetary policy only works for a relatively short period of time. We have had six or seven years of it at this point and I think that’s hardly a short period. There are all sorts of other issues that I won’t go into now, but that’s where we are.
ET: If we have reached that exhaustion level, then the next step is NIRP right? Is that the natural progression given the “panic mindset” that you alluded to?
WW: You used exactly the right word, it is a mindset. They believe that they understand how the economy works and they are going to do more of what they consider to be a good thing. And we’ve seen this process at work over the course of the years. I remind you that, when the Fed started this ultra-easy stuff, the Europeans were very hesitant to go into it. But, in the end, Mario Draghi and the ECB have gone into it with both feet and are proceeding along the broad lines of what the Americans initiated.
The thing that strikes me about NIRP is the possible analogy between the zero lower bound and quantum mechanics. The Newtonian laws of motion apply as long as the body in motion is not too small and is not going too fast, otherwise you need to make use of quantum mechanics and the theory of relativity. And maybe with monetary policy there is a similar kind of a phase change that occurs at the zero lower bound.
The Europeans were concerned about this, based on earlier Danish experience when the central bank started charging negative rates on excess reserves held by the banks at the central bank. The expectation is that this will lead to lower lending rates. But you can easily think of a story where this is not the outcome because those negative interest rates cut the banks’ profit margins. And then the question is what will the banks do to restore them?
Well, one thing they could do is lower the deposit rate. I read in the Financial Times a few days ago that Julius Baer in Switzerland is thinking about doing just that. But then the worry is that people will take their money elsewhere, take it out in cash or whatever. If this is not possible, then what is possible is increasing the lending rate. What you end up with is a counterintuitive but highly plausible alternative description of what these policies are going to give you. So in the end they may end up being contractionary and not expansionary.
So totally experimental in any event.
ET: Actually we do have some empirical evidence after some central banks adopted NIRP, such as Switzerland, Sweden and Denmark. As interest rates fell, people saved more, which is the opposite of the policy objective. It seems that because people, particularly the older folks, earn less interest they have to save more to meet their needs.
WW: Absolutely. But I would associate that argument more with the general question of whether additional quantitative easing will produce the desired increase in aggregate demand. The NIRP is sort of an extension of that kind of argument.
There are lots of reasons why lower interest rates might produce lower consumption. For example, think about the people who are saving for an annuity or a pension for when they retire. If the roll-up rate is going down, aside from working longer, the only solution is to save more. You need a higher base, given that lower roll-up rate, to achieve a particular target level of wealth to buy an annuity of the desired size at the point in time when you want to retire.
There are all these distributional issues to consider too. You know, all these policies have buoyed asset prices a lot and richer people – the ones who have the financial assets and the big houses whose values have increased the most – have gained the most. Conversely, middle class people whose financial assets are largely in the banks, have lost out. Since richer people tend to have a lower marginal propensity to consume out of both income and wealth, then these redistribution effects could cause the economy to grow more slowly, not more rapidly.
Andrew Smithers of the Financial Times has offered a compelling explanation as to why business investment has also been so weak in spite of monetary conditions being so easy. It relates to the unexpected interaction between lower interest rates and corporate compensation schemes. When interest rates go down it becomes cheaper to borrow money, which can then be used to buy shares thus pushing up equity prices and the value of the associated option compensation schemes.
So from the perspective of the senior management – and for that matter, the “sharp” holders of equities who know that the shares are overvalued – it makes a lot of sense to buy back shares because they are personally making a lot of money out of it. But in the process they are also hollowing out the corporation because they are cutting investment to hoard cash for the same reason. And the “dumb” holders who did not sell the shares in the buyback are left holding the bag. That shell of a corporation is not going to be able to produce the returns in the future the way it did in the past. And this is an unexpected consequence of the interaction between easy money and corporate compensation schemes.
As you can see there are many reasons why lowering interest rates – and in the limit NIRP – could lead to less spending and not more. Having said that, I did notice from reading the newspapers how this thing is spreading out. Haruhiko Kuroda, the Governor of the Bank of Japan, until recently maintained that there was absolutely no way he would ever do NIRP, not even thinking about it. Then he went to Davos a couple of weeks ago, came back and did it.
Insofar as the Americans are concerned, who are now outliers for not having negative rates, we had Ben Bernanke just two weeks ago saying the Fed should think about it. Alan Blinder apparently said it’s a good idea, and Janet Yellen, who previously said it is too dangerous, now says that the Fed should consider it. So here we have that mindset again.
ET: It’s creeping in. You bring up a number of important counter-arguments that should be considered in policy making, which gives us some hope in our economics profession. And yet it seems the default is always more of the same, with the consequences we have been discussing.
Let’s pick up on the issue of solvency you brought up earlier, which could also be frustrating the outcomes of central bank policies. We can use Portugal as a case study in this regard. Until recently it was under the direct economic supervision of major international financial institutions and all the brainpower that comes with it. The previous government, replaced only a few months ago, had been praised for implementing a very strict austerity program.
And yet, the economy pretty much stagnated, unemployment remained high and government debt levels as a function of GDP exploded – to the point where nominal growth for the most part does not cover government interest payments. The banking sector in turn remains in a dicey situation, with several high profile bankruptcies just in the past months. While central banks are critical in providing liquidity, how can a country like Portugal become solvent again?
WW: Here you have one of those unintended consequences I alluded to before. It turns out that these ultra-easy monetary policies induce people to take on more debt. In the longer run it’s those debt problems that become a headwind, and if that headwind is of such a magnitude that it affects the solvency of the banking system as well, then we have a real problem.
There is now a huge literature on this. You are familiar with Ken Rogoff’s and Carmen Reinhardt’s book on financial follies over the ages which, along with pieces by Jorda, Taylor and Schularick and others, describe the dynamics at work here. When you get a combination of an economy which is hurting because of debt problems, where the corporate and/or the household sectors are facing these big headwinds of debt, and in addition the banking system becomes challenged, with non-performing loans and the like, the resulting periods of unusually low growth can go on for a decade or more. Carmen and Vincent Reinhardt also did a big paper at Jackson Hole on this in 2010 where I was the commentator. If you get a joint problem of this nature associated with too much debt both in and out of the financial system you have a tiger by the tail.
Now specifically on Portugal, the McKinsey Global Institute recently published a paper on debt and deleveraging all over the world. Out of the six countries which had the biggest increase in sovereign debt to GDP ratios since 2007, four of them were in peripheral Europe, including Portugal. I have followed the Greek situation a little more closely and I know for a fact that in their case they have implemented actual fiscal measures that took out 18% of GDP out of the economy. In spite of this, and the fact that the private sector took a big haircut, the overall debt to GDP has risen to above 200% of GDP as GDP has sunk like a stone.
ET: So, clearly, some of what has been done has made things worse, not better. The question is what are the alternative policies when you are dealing with a solvency problem of this nature? And related to that, how to make debt service more manageable?
WW: The first thing I would say is to have less austerity and more pro-growth spending. Now I qualify each of these things with the recognition that sometimes and in some countries this will not be possible because of confidence effects in market. Nevertheless, European experience does point to the merits of less austerity as opposed to more. I particularly think that there are many countries, maybe Portugal is part of this, where there should be a lot more government money spent on infrastructure: the US, Germany, Canada, and the UK would certainly be included. There are needs for more infrastructure in many countries, and with the interest rates being so low, I really don’t understand what the hang up is.
I also think that there are a number of countries following essentially mercantilist policies and it would be much better if they re-orientated themselves domestically so that wages could get a larger share of incomes. In countries like Germany, China, Japan, South Korea, for a long period of time and still continuing, that sort of mercantilist approach basically said that you have to keep wages down. I think that has not been helpful, and that we could do more to encourage wage income and spending in many countries.
We also need many more write-offs – not just debt restructuring but actual reduction of the principal. Willem Buiter has written a lot on this, in terms of replacing debt with equity, so that the risks are more evenly shared. And lastly, we need more structural reforms. At the OECD, they believe that there’s still a lot of low hanging fruit out there, in terms of freeing up labor markets, product markets and so forth.
The answer to insolvency is not simply to print more money – it may get you out of the problem in the short-run but it simply makes it worse and worse over time. At some point, maybe where we are now, you truly get to the end of a line. You see that what you have been doing is just a short term palliative that is actually making the disease worse.
ET: We wrote about Greece a year ago and pointed out that the economic transformation being asked in connection with the new bailout was akin to converting a proverbial “couch potato” into an Olympic athlete almost overnight. Given how poorly they rank across a number of competitiveness statistics after being in the European Union for decades now, at best this is something that will take many more decades to turn around. It really makes you wonder what kind of shock therapy is needed to rehabilitate that economy.
There’s one other policy that while a political taboo might also be considered: leaving the Euro. Greece has tried the alternative, which is austerity – internal devaluation by another name – with very poor results. So why not give this one a go?
WW: This raises an important question. Suppose Greece exits and depreciates its new currency to stimulate exports and economic growth. Will depreciation prove successful?
In addressing this question, we get back to some fundamental structural issues. There is in fact a developing literature on this topic at the moment. In part, this literature is a response to the puzzle that both the Japanese Yen and Sterling depreciated a lot recently yet nothing seemed to have happened in terms of the external side.
I think there are a lot of grounds to believe that depreciation works less well than it used to. First, in Greece we know that wages have come down a lot. But the country is characterized by such a degree of oligopoly and rent-seeking that all that’s happened is that profit margins have gone up. As a result, there’s no signal coming through prices to get a change in resource allocation from non-tradables to tradables.
Second, you have all sorts of institutional barriers to entry and to exit of old unproductive firms – in Greece it takes almost four years for your average bankruptcy proceeding. If you have all these institutional impediments to the resources actually moving from the non-tradables to the tradables this is an excellent reason why depreciation might not produce the results intended.
Thirdly, it might not work because, in the end, all that will happen is that inflation will go up and any real benefits you may have gotten in the first instance just get eaten away.
Now, we should be thinking about all these alternatives in a serious way. They are very important issues. But you should not just immediately assume that a depreciation is going to be output expanding, particularly via an improvement in the current account.
Another thing that concerns me a great deal, and we can see this in spades inside the Eurozone, is that the portfolio elements and revaluations associated with depreciation are potentially much more important than trade effects. How are these people going to pay all these external debts which are denominated in Euros when they are earning revenues in a new but depreciated currency? To say nothing about the legal problems, there would be lawsuits left and right.
George Soros made the point, in the Financial Times a while back, with an article titled “Germany Should Lead or Leave”. His view is that you could avoid a lot of problems if the Germans left, not the Greeks. When currency unions split up in the past, normally it was the creditors who left. They see the writing on the wall and they are out of it. If anyone leaves it should be the Germans, the Dutch or whoever wants to go along with them. The debtors would keep the euro, minimizing legal battles, and the creditors would have to be cooperative to minimize their losses. That’s what Soros thinks.
The problems associated with leaving would be very great, so you would want to think very carefully about it. What are the benefits and what are the costs? Barry Eichengreen talked about this a few years ago in an article for Project Syndicate. He felt that an exit would precipitate the “mother” of all crises. And the other problem is you would have to do all your thinking in secret because the minute the people get a whiff of what was going on you would see the “mother” of all capital outflows.
ET: What is your view on using actual cash – notes and bills – as a monetary tool to stimulate the economy? It seems to us that having a stimulus instrument that does not add to the debt burdens of countries has some appeal. And it goes straight to the real economy, bypassing bank managers who may be reluctant to lend that money out. Aren’t the Swiss voting on a similar scheme in fact?
WW: I had an exchange of views in Project Syndicate with Adair Turner on this. Essentially what it comes down to is the question of helicopter money: the government spends the money and the central bank prints it. The particular variation here is you’re saying the government doesn’t actually spend the money; they just print the notes and give them to the ordinary citizens who will spend the notes.
Well, a number of points can be made about this. If you give people notes, and you’re putting more notes into the economy than they want to hold, the first thing they’ll do is take the notes and deposit them in the banks again. So it really doesn’t make any difference whether a central bank pays for a deficit with notes or through a cheque that is deposited and shows up as increased reserves held by banks at the central bank.
ET: True. They could also use them to reduce their debt loads…
WW: Right, I was coming on to that. My first point is that there’s nothing magical about notes. People hold as many of them as they want and the rest they put in the bank.
Now, I will contradict myself by saying that if the actual printing of notes was taken as a sign of the extraordinary problems being faced by the government, you could end up in a Zimbabwe-type scenario. And that could lead to hyperinflation almost immediately.
OK, having said that, if you give people notes or a government cheque, what will they do with the money? They might spend it or, as you have just said, they might actually save it. The latter is more likely in a high debt environment. Whether it’s high existing levels of household sector debt, or whether it’s a Ricardian equivalence where they see-through the government and realize that government debt is really their debt and higher taxes down the line. So they might just sit on it and not spend it.
In fact when you think about it, remember the old multiplier debate? Tax cut multiplier versus expenditure increase multiplier, which is greater? It was commonly said that the expenditure multiplier was larger because, when the government spent the money, it was buying goods and services with money that ended up in people’s pockets, which they could then spend again. But the problem with the tax cuts is that we’re back to what we just described. Getting a bank note or a check from the government is almost identical to a tax cut, the benefits of which you may or may not spend.
The question is always what will the people do with the money? And I think the answer could be nothing. So this is a less useful way to approach the problem. If there is something to be said about government expansion – I stress the word “if” – there is less to be said about doing it through notes.
Another thing worth mentioning is the suggestion that that the reserves held in the central bank are not debt. They are not liabilities of government. I think that’s just totally wrong. The central bank is 100% a creature of the government. So if you put the two balance sheets together and net them all out, whether it’s cash issued by the central banks, or whether it’s bank reserves on the liability side of the governments accounts, it’s all government debt.
Well, then you might then say that there is no problem with this kind of debt because it is debt that doesn’t pay any interest. But what if there are so many reserves in the system that the central bank has to take them out at some point? And here the government really only has two choices: either the central bank sells assets, which are then interest bearing assets held by the private sector, or it pays interest rates on the reserves, in order to increase the demand for reserves commensurate with increased supply. So you end up in a world where you are paying interest on that debt.
I think back to that article written by Sargent and Wallace in 1981 titled “Some Unpleasant Monetarist Arithmetic”. There’s also a book written by Peter Bernholz about monetary and political regimes and inflation. Both of those pieces, the first the theory and the second the historical facts, suggest that if a government is running a big deficit and it’s already got a big debt, it has a big problem. And the problem is that the government has to borrow because the deficit is so great and the employees need to get paid. However, nobody will lend them the money because the stock of debt outstanding is too high. And the only answer is to go back to the central bank.
Peter has a magic number. If 40% of all of the expenditures of the government are being financed by the central bank, the historical record indicates that hyperinflation is significantly more likely. And what is really interesting at the moment in terms of magic numbers, for what all magic numbers are worth, is that the asset buying program at the Bank of Japan is now equivalent to financing 40% of government expenditures. We’re talking big numbers here.
I don’t think you need rational expectations, just people seeing the writing on the wall. Everything is fine until inflationary pressures or something else shocks up the interest rates. And the minute they go up, it becomes obvious that government debt service has gone high enough so they will have no recourse but to have the central bank finance still more. And when that happens the writing is on the wall, the currency collapses and the inflation becomes essentially uncontrollable. This is a highly non-linear process that cannot be captured by the econometric models that are in widespread use. They are essentially linear.
People say that all this stuff is innocuous, that “helicopter money” is a magic bullet to get us out of a debt problem. My own personal view – and I have to say that I hope I’m wrong – is that it is a highly risky and perhaps even terminally risky policy for countries that already have bad fiscal conditions. We should be thinking about the downsides.
ET: If high inflation rears its ugly head again, do you think central banks won’t be able to fight it? For instance, given the high debt load the US government has taken in recent years massively raising interest rates to curb inflation could create some serious fiscal problems going forward.
WW: I think it’s exactly so and it goes back to what we were just talking about. Suppose a country has a big debt, a big deficit, and a short maturity of debt and they raise interest rates. It’s entirely possible that this process of fiscal dominance not only begins but could be perceived to be beginning on the part of thoughtful investors. Then it turns into a flight to get out, and the flight then generates a dynamic which is self-fulfilling.
If you ask me who I am worried about today, I guess Venezuela is on top of the list, albeit a bit of an outlier. Brazil is a country that I think is very worrisome, with high interest rates, a bad fiscal position and short maturities.
The OECD over the course of the years has pointed out that Japan, the US and the UK are the countries that could have the most serious problems in this regard. However, the odd thing is that the OECD has been saying this for ages and yet everything in those three countries now has continued to be just fine. Conversely, you look at other countries like Ireland and Spain before the Eurozone crisis, which seemed to be perfectly fine, and yet the markets attacked them anyway.
I suppose the bottom line is that, while we can see the potential dangers building up here, as to when they will materialize we have no real idea.
ET: That’s the $57 trillion question as per the figure in that McKinsey report. It does seem that savers are surely facing some tough times ahead, with real and even nominal negative interest rates.
WW: Absolutely. As soon as you get into these kinds of scenarios where further damage is being caused to the health of the middle class that is already under severe pressure – you mentioned income distribution earlier – then you do have to think in a very serious way about what the social and political ramifications might be.
I mentioned before this group of researchers that included Martin Schularick. He began with a database documenting economic crises in a large number of countries over the last 100 years or so – a huge effort to pull this data together – and then expanded it to cover the political realm as well. He contends that after serious economic and financial crises it is very common to see a shift away from the political center, either to the left or the right. The left of course means more socialism and the right means more nationalism. The problem is that it’s all a big circle and you could end up with national socialism.
So we definitely shouldn’t understate the social and political ramifications from all of this.
ET: We’re seeing that in Europe and in the US, with candidates like Donald Trump and Bernie Sanders. Switching gears to the current macro picture, what is your assessment of the global economy? Are we going into a generalized recession or is the slowdown confined to some geographical areas and sectors? What is your number one worry in that context right now?
WW: As the whole tone of our conversation has indicated I’m fearful of a few things.
- One, we now have a global problem. This problem of debt and over-indebtedness is now no longer confined to advanced market economies but includes the emerging market economies as well – not least China.
- Two, I view the global economy as a complex, adaptive system. And the character of the complexity and the interdependency is such that, if we get a problem anywhere, I think we are going to have a problem everywhere. A very good example would be 2009, where almost overnight investment everywhere collapsed, even in countries that in the first instance did not have a problem. So everything is interconnected now.
- Three, everywhere you look it seems to me you can see a potential trigger. You look at China and it’s slowing, although nobody knows by how much because nobody believes the data. But things like railway transport and electricity use suggest China is slowing a lot. Unfortunately, if you look closely at the data, the conversion of the economy from investment to consumption is not really happening and the old growth model built on debt is coming to the end of its useful life. As well, you have problems in emerging markets and commodity producers – Brazil, Russia, oil regions – where associated fiscal difficulties could lead to greater social and political problems than might be expected in the advanced economies. In Japan, I think Abenomics is not working and will in fact backfire – raising prices when the typical salaryman hasn’t seen a salary increase in two decades equals a cut in real terms, meaning he will hunker down. For its part, Europe has a daunting list of problems – the Russian thing, the migration thing, the peripheral thing, the debt thing, and the absence of adequate political institutions to deal efficiently with all these problems. Even in the US people are talking about problematic student loans, low investment rates and the rising likelihood of recession.
Any one of these things could be a trigger for broader global problems. As White explained on Bloomberg TV...
My number one fear? That’s the same as asking me where it will start. When you view the economy as a complex, adaptive system, like many other systems, one of the clear findings from the literature is that the trigger doesn’t matter; it’s the system that’s unstable. And I think our system is unstable.
Where could it start? Who knows, I’d probably say China but I have no idea and nobody has any idea.
ET: Dr. White, thank you very much for sharing your thoughts. All the best to you.
WW: Thank you.