Interest rates. There is an emerging consensus that monetary policy has gone as far as it can. With interest rates at zero and bond yields in Germany, Switzerland and Japan negative, central bankers are impotent. In fact it could be argued that current policy could lead to another banking crisis, because banks cannot make any money out of maturity transformation with rates at zero. The recent decline in Deutsche Bank’s share price is indicative of a fundamental malaise. This is not to criticise central bankers for what they have done since the 2008 financial crisis. They have done what they were meant to do, cutting interest rates to zero and providing stimulus. Money supply has continued to expand, thus averting the catastrophe that befell the American banking sector in the 1930s, as documented by Friedman and Schwartz. The problem is that the velocity of money has declined so obviating the expansion of the money supply. This decline has not really been explained away by monetarists. If monetary policy cannot boost growth, what can? The answer may well be fiscal policy, as described by Keynes and illustrated in classic IS-LM model which demonstrates the interplay of the demand for goods and supply of money. What Keynes highlighted was the failure of policy when the equilibrium interest rate was less than zero, or the so-called liquidity trap. This renders monetary policy redundant and requires a more active fiscal policy. The problem is in part political. There is a prejudice against using fiscal policy as a stimulus with arcane debates about ‘Ricardian equivalence’, the notion that consumers believe that any tax cut now will be financed by a tax increase in the future and so increase saving to pay for it. Another prejudice is that government spending is inefficient relative to private sector spending. Finally there is the worry that government debt levels are already at very high levels relative to GDP. 90% is seen as a key level as studies have shown that governments start running into funding problems when the ratio rises above that figure. The first two points are indeed ‘prejudice’ – Ricardian equivalence has never been proved and there is evidence that government spending can ‘add value’ in certain areas. The problem with the 90% figure is that the studies were done in periods when interest rates were higher than they are now and debt servicing was consequently a larger burden. This is no longer an issue and indeed interest payments as a percentage of government expenditure have not risen despite the rise in government debt. Generally there seems to be capacity for governments to use fiscal policy and issue debt because investors have a high demand for such debt. Returning finally to the problems with monetary policy, the Bank of Japan has tweaked its policy to managing the shape of the yield curve rather than simply buying lots of government debt. This does make some sense as the shape is important but it also smacks of desperation given the failure of the Japanese to stoke inflation. At least the Americans seem to be able to achieve this with the Federal Reserve now expected to raise rates before the end of the year. Sadly they should probably let things lie for the time being with inflation being more of a good thing than a bad thing, but the Republicans in the US do not see it that way.

Growth. Attempts to forecast the short term outlook for the global economy are futile and more than likely to leave the forecaster with egg on his or her face. As an example, I forecast a pick-up in activity in mid-year based on some of the monthly indicators but little materialized. Four months later, I am tempted to say the same again and I could be encouraged by the rise in bond yields and the performance of equities over the last two months. But attempts at such forecasts are missing the point. What the weekly and monthly statistics are telling us is that there little volatility in economic data, and that overall growth is weak to moderate with no inflation and low interest rates. JP Morgan’s PMI index declined gradually from a level of 54.0 in March 2015 to a low of 51.1 in May of this year and has risen to 51.7 since then. At no point did they suggest a decline in activity. The OECD lead indicator says much the same thing. The best answer to a forecast about growth is basically more of the same. Indeed, the real problem with OECD economies has not been growth per se but interest rates, particularly the structural decline in real rates. As equilibrium nominal rates have trended toward zero, monetary policy has become ineffective and attempts to boost growth through yet more monetary stimulus have largely failed. Slowly but surely OECD governments are waking up to the issue and it will be interesting to see if a greater fiscal stimulus will have more success in boosting growth.