We are now discovering the limits of cheap money.
For more than four years, central banks around the world — led by the Federal Reserve — have aggressively pumped money into their economies to stimulate faster revival. These infusions are huge. From 2007 to today, the assets of major central banks nearly doubled from $10.4 trillion to $20.5 trillion, reports the Bank for International Settlements (BIS) in its just-released annual report. When these assets (bonds, mortgages and other financial instruments) are purchased, the sellers receive cash. The outpouring of cash aims to lower interest rates, push up stock prices and real estate values, and restore confidence and stronger economic growth.
The most charitable verdict on this massive monetary experiment is that it’s done modest good. In the United States, it did reduce long-term interest rates and, to some extent, bolster stocks. Even so, the speed of the U.S. recovery (about 2 percent annually) is roughly half the average of all recoveries from 1960 to 2007. As for the global economy, it grew 2.5 percent in 2012, down from the 3.7 percent average from 2003 to 2007, says IHS Global Insight. Few major countries are doing better now than before the financial crisis. Cheap money hasn’t been a smashing success. Still, when the Fed suggested last week that it might curb bond-buying later this year, stocks swooned.
That’s one downside: Cheap money is hard to reverse gracefully. The larger problem is that central banks are trying to do things beyond their powers. Says Stephen Cecchetti, the chief BIS economist: “Monetary stimulus alone cannot put economies on a path to robust, self-sustaining growth, because the roots of the problem preventing such growth are not monetary.” In the annual report, he argues that low interest rates might even be counterproductive. They make it easier to finance large budget deficits and may delay needed, though unpopular, cuts. (Created in 1930 to help settle World War I debts, the BIS now serves mainly as a forum for international financial cooperations.)
Cecchetti’s preference for deficit reduction is controversial; economists disagree about the need to cut deficits. But his main point is correct and may be understated. Cheap money can’t rescue the global economy. Indeed, though no one dares say it, there may be no plausible set of policies to neutralize all the forces retarding growth.
The most powerful of these in the United States, as I’ve repeatedly written, is the legacy of the financial crisis and Great Recession. Their suddenness and magnitude sobered and frightened people in ways that sapped vitality and optimism. Households, companies, bankers, government regulators — just about everyone — became more cautious and, in economics jargon, “risk averse.” Consumers skimped on spending; companies limited hiring and investment. Debts that seemed bearable quickly became burdensome. Firms and families “deleveraged.”
Technological advance, an engine of growth in the 1990s, also seems to have faltered. Economist Robert Gordon of Northwestern University argues that the information technology boom is weakening. A new study from the Federal Reserve provides some corroborating evidence. It finds that from 1995 to 2004, labor productivity — a measure of efficiency — in the nonfarm business sector increased 3.1 percent a year, with about half the gain coming from IT. From 2004 to 2012, average annual gains dropped to 1.6 percent, with IT providing slightly more than a third.
Finally, demographics may hurt. As Americans age, they may restrain their spending. (In 2000, the 65-and-over population was 12 percent of the total; by 2025, it is projected to be nearly 19 percent.) Their wants may not have decreased, but they don’t know whether they will outlive their savings. The decline in IRA and 401(k) retirement accounts — in many cases now reversed — could be repeated. Social Security and Medicare benefits could be cut. These uncertainties breed caution.
Cheap credit addresses none of these problems directly and, indirectly, does so only weakly. It can’t erase the memories of the financial crisis. It can’t create new technologies. It can’t make older people younger. At best, cheap money aided the housing recovery; at worst, it became a stock-market narcotic that can’t be withdrawn painlessly. Many countries face obstacles to growth that cheap money won’t magically remove.
This raises a larger issue. Economists have been taught in graduate school that advances in their discipline make it possible to stabilize and, within broad boundaries, control economic activity. But what if that’s not so? The ferocious debates among economists indicate that the consensus has broken down. Inevitably, there are better and worse policies; but in real time, it’s not always clear which is which. Business cycles endure. Market forces still dominate; the ability to subdue and reshape them remains limited. Time, as much as policy, may promote recovery.