129th BRE-CASE Seminar: Long-term effects of low-interest rate policy and the loosening of the monetary policy
Maintaining an exceptionally long period of low interest rates and cheap money has many consequences. The longer the period of monetary policy loosening lasts, the more difficult it is to start the normalization process. Cheap money gives governments a general sense of comfort, which in turn leads to the postponement of necessary structural reforms and fiscal and consolidation decisions. Cheap money policy and quantitative easing therefore cause omissions, since they do not bring about the changes necessary to restore potential output, said Dr. Przemyslaw Wozniak, an economist at the EC’s Directorate-General for Economic and Financial Affairs (DG ECFIN). Moreover, cheap money lowers the propensity to save. In the long run, this may lead to a reduction in capital accumulation, which reduces potential GDP.
In the United States, potential GDP fell from more than 3% before the crisis of 2007 to just above 2% and is predicted to remain at this level until 2023. The crisis led to large deficits in a number of areas that have an impact on potential output, while better use of the economic potential depends on other elements of economic policy to a greater extent than monetary policy. Thanks to the cheap money policy, some time has been bought. Alas, it was not used properly. Undermining the reputation of central banks is another serious problem. By buying government securities, banks help governments to expand consumption.
However, taking decisions on granting interventions and aid (to markets and institutions) weakens the credibility of central banks, as these choices have always had and will have redistributive effects. As a consequence, central banks have been subordinated to the political sphere. Cheap money encourages financial institutions to seek higher rates of return, that is to take more risks, and therefore increases the risk of the formation of bubbles in asset markets. And what are the consequences for the banking system? Such a long period of loose monetary policy may encourage banks to take excessive risks, which delays the process of repairing their balance sheets and weakens the whole banking system. Markets easily become dependent on low interest rates and loose monetary policy. This, in turn, means that a departure from the current policy of quantitative easing is highly problematic; for example, the negative effects of even a gradual tightening of monetary policy are increasingly mentioned.
What happens to the large amount of money created by the central banks? According to Prof. Jan Winiecki, money created in this way has little effect on growth or inflation, due to the persistent climate of political and economic uncertainty. First, entrepreneurs and investors are under pressure from populist politicians who want to seize the latter’s incomes by invoking well-known slogans like the one coined by President Obama, who famously announced that "Warren Buffett 's secretary cannot pay a higher (tax) rate than Warren Buffett himself". However, in the first draft of his proposal, each married couple with an annual income of over 250,000 USD would be labelled “millionaires”. This means that, in practice, the group of alleged millionaires would include all medium-sized companies’ owners, as well as a plurality of small businesses. Second, slow economic growth in the Western world increases the level of entrepreneurs’ uncertainty about the prospects of sustainable growth in demand for their products and services. Those entrepreneurs who have a decisive influence on the formation of GDP are in a special situation: on the one hand, they do not see major growth prospects for their companies, but on the other hand, they are not sure whether or not a bigger than ever part of their decreasing rather than increasing incomes will be taken away from them. At the same time, it is worth remembering that the top 20% of top-earning Americans contributes more than 80% of total income tax (collected in the country). Third, what is the cause of reduced lending? Due to the prolonged period of uncertainty, potential borrowers generally have no great desire to apply for loans. Generally speaking, lavishly "printed" money rarely reaches the real economy, and almost never reaches the real private economy. Then what happens to this large amount of money created by the central banks? It is acquired by the financial sector.
Low interest rates and loose monetary policy were debated by the panelists of the 129th BRE-CASE Seminar, which took place on November 7th, 2013. The texts of the panelists’ speeches and main theses of the discussion that followed will be published in BRE-CASE Seminar proceedings No. 129.
The webcast of the seminar proceedings (in Polish) can be viewed here:
http://bankier.tv/dlugofalowe-skutki-polityki-niskich-stop-i-poluzowania-polityki-pienieznej-129-seminarium-bre-case-14191.html
