The painfully slow recovery and tepid to the efforts of Central Bank inflation can become a plague for developed economies, if policymakers won’t find a natural extension of stimulus measures when interest rates reach their lower limit. This is what the Fed’s top manager, John Williams, thinks, and the current experience of the EU and Japan shows that he is absolutely right.
“Experience teaches us that it is better to start preparing in advance than to wait too long,” said Williams, probably hinting at the active research work and ingenuity of the Fed in search of a replacement for QE. One of the alternatives, which I discussed in detail in yesterday’s article, could be a rate “peg”, which is very similar to targeting the yield curve of the Bank of Japan, but has significant differences.
According to Williams, the inability to adequately prepare is equivalent to preparing for failure. This indicates a serious disappointment of some officials with QE potential, in particular, the advantage of its side effects over advantages.
Low birth rates restrain population growth in developed countries, and the pace of technological progress has changed from high to more moderate. Both factors hold back growth in the long run. If the growth rate of aggregate output slows down, this leads to lower savings in absolute terms, which in turn limits investment growth. Population aging leads to an increase in the share of savings in average consumer’s disposable income and a decrease in the share of consumption. The excess supply of borrowed funds means a natural decrease in “neutral” rate in the economy (that is, which does not stimulate nor slows down growth), which we can currently observe.
As the rate approaches zero, the central bank loses its ability to influence aggregated demand by lowering rates. Obviously, the power reserve is reduced. Paying attention to the factors described above, we can conclude that, if a serious change in the demographic trend of developed economies (stimulation of fertility, migration) or acceleration of scientific and technological revolution won’t occur, the neutral yield will continue to decline. Without exaggeration, this literally disarms the world’s major central banks.
Williams’ early career as a researcher at the San Francisco Federal Reserve Bank is known for his works dedicated to understanding what drives changes of the neutral rate. Now he is trying to introduce his views on policy, mainly by proposing to keep rates low for a longer time, hoping that it will be easier to control the inflation “overshoot” than its chronic lagging.
Inflation, measured through growth in consumer spending, grew by 1.6% in March in annual terms, falling behind the target of 2%.
According to Williams, low inflation is no longer surprising investors and has become the norm.