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Can prolonged periods of negative real interest rates ever be good for economies in a globalised world?
Anders Aslund, senior fellow of the Peterson Institute for International Economics, argues no.
In an article published on Wednesday he presents some interesting stats to support the idea that any prolonged period of negative real interest rates will almost always result in unwanted and dangerous side-effects.
And that being the case, consider this.
At present, Aslund says, all the world’s major central banks are maintaining negative real interest rates even though, in the case of the eurozone, annualized inflation rose to 2.6 per cent in March.
As Aslund observes:
Yet there are still protests against the European Central Bank's intention to raise its leading rate of 1.0 percent to 1.25 percent a year next week, while the US Federal Reserve and the Bank of Japan maintain zero interest rates. Permanently negative real interest rates distort world financial markets dangerously. Central banks should face reality and raise their rates faster and higher.
But here’s the really interesting point (our emphasis):
Loose monetary policy can only stimulate economic growth if other conditions for growth are in place. Today, much excess capital goes abroad as carry trade to emerging markets where investment conditions are more lucrative, destabilizing all kinds of markets. Princeton Professor Hyun Song Shin has used the net non-core dollar liabilities of 160 foreign banks in the United States, as an assessment of a major part of the carry trade. Currently, it amounts to $600 billion.
By coincidence, that is accidentally exactly the volume of the US Federal Reserve's second quantitative easing. This money does not stimulate the US economy as investment or consumer demand. The outcome is instead a demand shock that destabilizes the global economy, prompting policymakers in emerging economies to complain about currency wars and capital inflows causing overheating.
Effectively, since investors are no longer keen to invest in countries with real negative interest rates, they must seek out higher yielding temporary investments elsewhere.
But since even these are lacking in number, Aslund says the carry trade is inevitably concentrating itself on commodities, especially oil and gold.
As for the argument that the output gap justifies easy monetary conditions, Aslund has a firm view. It’s illusory:
On average, the United States has had a slightly negative real interest rate since 2002, measured as the federal fund rate minus the consumer price inflation. It is time to pay more attention to financial stability than illusory output gaps and to blame the key culprits, the permissive central bankers, before they cause more damage.
Related links: A gap in the output gap "“ FT Alphaville More on that commodities vs global demand chart – FT Alphaville Debunking the size of the carry trade - FT Alphaville Roubini: Mother of all carry trades faces an inevitable bust "“ FT James Bullard and QE2 "“ oil price update – FT Alphaville
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