Martin Wolf Needs a Supply Side

Peter Warburton - 21st October

The world bemoans two-handed economists with splinters in their backsides (from spending too much time sitting on the fence). This charge cannot be levelled at the chief economics commentator of the Financial Times. Over many years, Martin Wolf (The unwise war against low interest rates, 19 October) has been utterly consistent in his defence of western central bank economic orthodoxy. While he has long argued that it would be difficult to revive demand, he must be perplexed that the protracted use of zero interest rates and central bank asset purchases (originally intended to simulate even lower interest rates) has not been more successful in this endeavour. His well-argued columns barely conceal his frustration. But Mr Wolf is a one-sided economist: the thrust of all his arguments is that private demand is deficient and must therefore be supplemented by public expenditures. He is so confident of this diagnosis that it seems that he has not even considered other explanations for the prevailing economic impasse.

Without subscribing for a moment to the hypothesis of a global saving glut, let us examine some other reasons why corporate saving in advanced economies should remain strong in the face of zero, or negative interest rates, yield curve suppression and central bank forward guidance. One, the real cost of capital is a predictor of the real return on capital: companies are suspicious that the profitability of capital in the medium term will be much lower than today. Moreover, successive rounds of monetary policy easing and experimentation have not inspired business confidence. Frequent policy innovations are unsettling to business and warn of greater variability of future economic outcomes.

Two, the return on business cash has two elements: the monetary return and the option value. When central bank-endorsed asset prices are rich – both bonds and equities – the option value of cash is high because of the likelihood that assets may be acquired more cheaply in the future than in the present. Reducing deposit interest rates to zero, or even below zero, need not render cash unattractive.

Three, the enthusiastic embrace of theories of “secular stagnation” by policymakers sends a very different message to business decision-makers than that intended. Instead of being thrilled at the idea of a lower terminal interest rate on government debt, they consider what a permanently weak growth environment means for their investment plans. Why invest for an immiserated future?    

Four, the effect of large-scale central bank purchases of government bonds is to shrink the available supply of high-quality yielding assets, driving investors to search for yield in equities and riskier corporate bonds. The cash generative companies whose share prices are bid up to high earnings multiples are well aware that this compliment is conditional on their agreement to distribute rather than invest.

In sum, corporate cash-hoarding behaviour can be viewed as entirely rational in the light of the distorted incentives created by persistently low interest rates, QE and forward guidance. The prime minister is entirely within her rights to question the appropriateness of the overall framework of policy-making at the Bank of England.

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