Federal Reserve Chair Janet Yellen's upcoming speech at the Jackson Hole Economic Symposium will likely offer a fairly constructive outlook for the economy. This will lead to speculation about a rate hike for September, but the markets will price in a December hike. However, by focusing narrowly on the potential timing of the next rate hike, investors may be missing larger policy inflection points:
- The passing of the baton from monetary to fiscal policy
- Implementation of monetary policy globally
Monetary policy has been the dominant policy tool post global financial crisis, as central banks from around the world have repeatedly fed their economies caffeine shots in an effort to jump-start activity. The central bank baristas have moved from serving basic coffee to extra-large, triple shots of espresso just to keep the pulse ticking. It has become clear that the marginal benefit of additional (unconventional) monetary policy measures is limited; yet the longer-term costs remain unknown and potentially large.
The move to negative rates by the European Central Bank (ECB) and Bank of Japan (BOJ) this year have potentially reached the tipping point where the short-term negative impacts – higher savings rates by consumers and weaker bank profitability – may have more than offset the impact of lower borrowing costs. Additionally, negative and ultra-low interest rates globally may be leading to distortions across financial markets, potentially creating new risks (asset bubbles) and making it more difficult for the global economy to flush out its excesses (capacity). This has led to a broader re-think of monetary policy globally:
- The BOJ announced a formal review of its monetary policy framework in July.
- The Bank of England (BOE) effectively ruled out negative rates in its August easing and provided support to bank profitability through a targeted lending scheme.
- In the U.S., a recent paper by James Bullard, president and CEO of the Federal Reserve Bank of St. Louis, and essay by Williams have challenged existing monetary policy paradigms.
The decreasing potency of monetary policy has led to the passing of the baton to fiscal policy, with Japan announcing a stimulus package in July and the UK poised to provide fiscal stimulus in the wake of Brexit. Additionally, the U.S. looks set to increase fiscal spending regardless of who wins the White House. European Monetary Union budget rules will most likely leave Europe behind the rest of the world in the shift to increased fiscal spending.
Will fiscal policy be able to jump start global economic growth?
In the short run, the answer is yes, as increased fiscal spending will translate directly into higher GDP growth. The impact will largely depend on the form of fiscal spending and its related multiplier. Spending on "investments" such as improved infrastructure, education, or publicly funding R&D have the potential to increase productivity, leading to higher economic growth over time. Spending on pork barrel projects (aka "bridges to nowhere") or transfers (e.g., payments) to consumers will have little-to-no impact on future productivity and growth.
Focusing on the need to drive improved productivity to lift the long run rate of the economy will ultimately require a pivot to significant structural reforms, which involves governments changing how much authority central bankers have to execute economic policies, as well as who is making these decisions. While these changes may lead to improved long-term outcomes, governments do not yet appear to be ready to commit to them.
This week, the financial community will be focused squarely on Jackson Hole. However, rather than focusing on individual rate hike decisions, it is more important to look at the switch from monetary to fiscal policy, and possibly structural reform, to assess our timeline for realizing long-term economic growth.