Mr. White, in response to the economic slowdown, central banks around the world have left the path of monetary policy normalisation. Are you surprised about this U-turn?
No, not really. The reaction was in a certain sense almost inevitable. During the market wobbles at the end of last year, the Fed realized that the effect of higher rates could be slower growth that nobody wanted. And so they backed off. The U-turn is just another manifestation of that worry what would happen next. Plus, in central banking, there is a bias towards loose policy and lower rates.
Why is that?
With public and private debt at record highs, we are in a debt trap. When you are in a debt trap it means: you know that you want to raise rates to bring the expansion of debt to an end, but you can’t because raising rates will cause all sorts of problems, for example hurt growth and increase debt servicing costs. There are also political-economy-constraints. High government debt and deficits mean that higher rates are going to hit the government.
Are there other reasons for the loosening bias?
The exchange rate is another. When you tighten monetary policy, the currency appreciates. But most countries prefer a weaker currency. That means, everybody is caught in that trap. And then there is the question of blame. When rates go up and a recession follows, central banks will be blamed, not the politicians. Put all these things together, it is clear that delay becomes the default option.
How did we end up in the debt trap?
We were encouraged to do this. Just think what we have been doing since 2007. Monetary easing is an invitation to take on more private sector debt. And fiscal expansion is by definition an increase of government debt. Both instruments carry the risk of higher debt levels that eventually will kill you.
But the actions taken by the central banks during the financial crisis 2008/09 probably avoided a worse outcome.
In the early days of the crisis, central banks were right to do what they did. But post-crisis, the reliance on monetary policy to sort out all problems in the economy was too excessive. Debt problems are insolvency problems. Central banks are in the illiquidity business. Their policies made the problems worse because they have been encouraging more debt. And this started long before 2007. Monetary policy has been very asymmetrical over decades. Easing has been more pronounced than tightening. So we ended up with zero interest rates. At the fiscal side, we have had the same asymmetry so that government debt ratios have ratcheted up.
For politicians, loose fiscal policies can be a strategy to please voters. But where does the decade-long bias towards loose monetary policy come from?
The inflation-targeting regime is in part the problem. Price declines were considered to be a danger. For the last twenty years, monetary policy has leaned towards inflation being too low. In a downturn, rates were lowered because inflation was under control. But in the upturn, they were not raised back to old levels.
But declining prices can be very harmful as the Great Depression learned us.
In history, there have been long periods where prices have gone down and the economy has been growing quiet vigorously because productivity increased. That was more the rule than the exception. The Great Depression, where prices and output were declining, was the exception. However, that exceptional event left a huge imprint on people’s mind and is now thought to be the norm.
You mean central banks should have allowed prices to decline?
At least prior to 2007. After 1990, the combination of China and India coming back to the global trading system and importing western technology and the increase in global manpower has to be treated as a positive supply shock. It pushed down the price level. And that should have been allowed to happen because it did not harm anybody. People were able to buy more stuff, producers made more profit, everybody was gaining.
One way to deal with too much debt is inflating it away. Is that a viable solution?
A little bit of inflation continuing over a long period of time can work wonders on the debt problem by reducing the real rates of return of the ones who own the debt. It is a rather gentle way of getting out of debt problems. We saw a lot of this in the post-war period. It is known as financial repression.
Will it also work in the modern world?
It’s not impossible, but in a world with open financial and capital markets it won’t be as easy as in the post-war era. If one country decides to take the path of financial repression, people will put their money to some other country and another currency. That is the danger of financial repression in the modern world. Either you have very strict capital controls, or you have a system where everybody does financial repression at the same time.
Are you worried when you follow the current debate in the US about Modern Monetary Theory?
I am a little bit. In a nutshell, what these people seem to be saying is that we need more active fiscal policy and that central banks should keep monetary conditions loose. It makes a lot of sense as long as you carry it not too far. The advocates of MMT think that debt levels don’t matter as long as you can print money in your own currency. But that idea is all wrong. History tells us that this can wind up very badly.
But the idea of more fiscal easing seems very appealing to many.
Yes it is, and I partly agree. I think we should have been using fiscal rather than monetary expansion over the course of the last couples of years. But we should have done it aligned with a mechanism that ensures that the policy tightens as things get better.
Are you advocating a debt break like we have it in Switzerland or in Germany?
I don’t like what you have done in Europe. I just say we should be very clear about the medium time framework and have legislations in place that will ensure that we are going to have much tighter fiscal policy when things get better. That might take the steam out of the upturn but would put us on a more stable fiscal path. But at these debt levels, anticyclical fiscal and monetary policy alone will not solve the problem. You also need to allow writing off the debt and restructure it.
That sounds painful. How could it be achieved?
You must identify which debt is not serviceable and take steps to make sure that it is written off. The supervisors in the banking system have to force the banks to restructure as opposed to provide support to zombie firms. In the next recession, we should have a combination of fiscal stimulus and a credible longer term debt sustainability target and pay much greater attention to debt restructuring. But nobody likes to talk about this.
Critics of fiscal and monetary expansion stress the danger of hyperinflation and refer to countries like Zimbabwe. But is this a fair comparison? The US is much larger and runs the world currency.
I agree, a collapse of the currency and hyperinflation are much less likely in a large economy and even less likely if that large economy provides the world currency. But the underlying processes are the same. The problems of hyperinflation never start with the central bank. They start with the fiscal authority that lets its finances get out of control. At one point creditors get worried and stop funding. Then the government turns to the central bank to get the money. The more it does, the more people are aware of the inflation danger. And they flee the currency.
But the dollar is not in demise. People seem to have confidence in the US and its currency.
Regardless of who you are, if you do not maintain a degree of order over your fiscal and external circumstances, there will be a price to pay. In the case of the US it will take longer, but there is already a murmuring of concerns about the dollar being the world currency because the US has a twin deficit at the top of the business cycle. And the Trump administration is using the dollar as a geopolitical weapon, what the Russians, the Chinese and the Europeans do not like. We are starting to see the beginnings of a backlash.
How could the global monetary system be put on a more stable footing?
The fundamental problem is that we do not have a global monetary system. We have a monetary non-system, in which central banks can do what they want. The manifestation of this is the explosion of their balance sheets.
What do you suggest?
I don t’ want to go back to the gold standard, but at least it was a set of rules that made sure individual countries could not do things that were harmful to themselves and also to others. We need a system that stops countries from letting their central bank’s balance sheet explode. The US has the privilege of running the system, but there is no interest in talking about this.
If not the US, who else could initiate reforms? What about the role of the BIS you used to work for as chief economist?
The BIS has no power, it is just a place where experts get together, talk and agree. Then they use the moral authority of that international agreement, so called «soft law», to convince people at the national levels to pass laws. The only institution to deal with it might be the IMF. There were a number of attempts to get the IMF to try to discipline its members. But that does not work because the creditors who do not need the IMF money are not listening to the fund. And the biggest debtor, the US, is not listening either because it has the dollar.
What does all this mean for smaller countries such as Switzerland or Canada?
We are both totally at the mercy of the monetary non-system. We cannot deviate from the course that the US and the Eurozone go because of the effects on the exchange rate. You in Switzerland ought to tighten monetary policy to prevent a bubble in the property market, but you can’t because of the implication on the franc.
Within the Fed, there are discussions to allow above-target inflation for a period of time. Is this reasonable or a matter of concern?
All of the debate is about finding a new framework that will allow the central bank somehow magically to raise inflation expectations. The idea is that inflation is too low and inflation expectations have to be raised. That comes out of the models they are using. In these models, expectations play a huge role. In my opinion, the approach is doomed to failure. Inflation expectations won’t rise.
What makes you so sure about it?
Why would you expect inflation expectations to rise when the Fed has no credible instruments to make them rise? Rates are already low and QE has already been used and will not have the same effect again. It reminds me of the situation years ago in Jackson Hole when there was a recommendation for the Bank of Japan’s Vice Governor Yutaka Yamaguchi to just raise inflation expectations. His answer was exactly that: How can I raise expectations without having the instruments? Again, I think none of this stuff will work and it is totally misguided. It is driven by the analytical framework the central banks are using. But I think their framework is not working in the real world.