Citi’s Chief Economist Willem Buiter recently wrote the following regarding ECB’s QE policy failure which the FRA felt would be instructional if US economic graphics (Charts #1 to #6) were added to highlight that it isn’t just an EU problem, but rather a failed policy initiative that has now becoming counter productive and systemically dangerous if the ECB and BOJ were to continue with it and if the Fed & BOE retreat once again to it.
We believe that a common factor in the relatively low response of real economic activity to changes in asset prices and yields is probably the fact that the euro area remains highly leveraged. The total debt of households, non-financial enterprises and the general government sector as a share of GDP is higher now than it was at the beginning of the GFC. (Charts 1)
There has been some shift from the private sector to the public sector, but the overall debt burden remains unprecedentedly high for an economy in peacetime (and for which the debt incurred during the last major war (1939-1945) has long since been worked off). (Chart #2)
The wealth effect of higher stock prices appears to do little to boost private consumer expenditure (Chart #3)
and the lift given by higher stock prices to ‘Tobin’s q’ does not appear to have stimulated private capital expenditure much. (Chart 4)
The weaker external value of the euro has clearly increased profit margins in exporting and import-competing industries and may have boosted the stock market valuations of internationally active Eurozone-listed companies, but its effect on the volumes of exports and imports appears to be moderate (in part because a number of other countries are pinning their hopes on generating a bounce in inflation and activity through weaker exchange rates, too). (Chart #5)
Extremely low interest rates have boosted residential mortgage borrowing in Germany and caused German house prices to rise at a, by German standards, alarming year-on-year rate of six percent during several months in 2015.
- Excessive indebtedness means households save much of any increase in disposable income in an attempt to pay down the debt.
- Highly indebted governments, prompted by necessity (limited market access) and/or by the constraints of the Stability and Growth Pact, are less likely to cut taxes or to boost public spending on real goods and services when lower debt service costs raise their disposable incomes.
- Corporations, even if they are not debt-constrained, are unlikely to boost investment when interest rates go down and the cost of capital falls because of persistent excess capacity amid an uncertain outlook for top-line growth and profits.
- Profits generated by favorable movements in asset prices (including the exchange rate) are distributed to shareholders (who save a large share of this) and used for share buybacks or debt repayment.
To the extent that monetary policy has had an effect on real activity, and will have some incremental effect on activity, it may not be entirely sustainable. This is because part of the effect has been by bringing forward demand from the future, such as major purchases, including for cars or construction.
That suggests that monetary policy, even if and when it has been effective in stimulating activity, will run into diminishing returns even in sustaining the levels of activity it helped to boost.
Quantitative Easing was possibly a viable policy initiative immediately following the 2008 Financial Crisis. However, it was sustained much too long and the global distortions it has created has left the world in a highly fragile state. The current economic state is both unstable and critically exposed to an unexpected shock.
The central banks are trapped! They can neither stimulate growth nor reduce the global credit/debt levels and leverage without catapulting the global economy into an economic depression.
The Central Banks and Citigroup now see the only way out of this trap to be more aggressive policy initiatives like OMF and NIRP!