The annual report from the Bank of International Settlements (BIS). It hardly sounds like the year’s best read. But ever since its prescient pre-crisis warnings about stresses building up in the financial system, the bank’s annual missive has become a must read. It provides plenty of ammunition to the vocal Cassandras who think the world economy is going to collapse, and plenty of pertinent insights for the rest of us to think about.
The 2015 version was released on Sunday and, at the very least, I’d recommend sections I, II and VI. Its biggest issue is the world’s dangerous addiction to abnormally low interest rates:
Globally, interest rates have been extraordinarily low for an exceptionally long time, in nominal and inflation-adjusted terms, against any benchmark. Such low rates are the most remarkable symptom of a broader malaise in the global economy: the economic expansion is unbalanced, debt burdens and financial risks are still too high, productivity growth too low, and the room for manoeuvre in macroeconomic policy too limited. The unthinkable risks becoming routine and being perceived as the new normal.
I’d agree with all of that and firmly believe that the risks of extending the period of ‘emergency’ monetary policy are underappreciated. The impact on business investment can be negative – why would any business invest when the central bank thinks things are so bad? And there is nothing in the tank to help mitigate the next economic downturn. As the BIS put it, “Of what use is a gun with no bullets left?”
But they are naïve in their prescriptions. Central bankers are human. And human behaviour is best understood by psychologists, not economists. It is a rare human that will risk their career and reputation by substituting a short-term and known risk – derailing a ‘fragile’ economic recovery –for an unquantifiable and longer term one – financial risks building up because of a sustained period of ultra-low interest rates.
Interest rates are not going back to ‘normal’ until the evidence that they need to is irrefutable. By then it will likely be too late.
There is, however, one short paragraph in the report that represents one of the easiest fixes you could imagine. The way we report GDP is absurd. Fixing it is straight forward, will hardly inconvenience a person and will make economic decision making a lot more rational. Here’s the BIS:
Politically, [ageing populations] heighten the temptation to boost output temporarily through demand management policies: the tyranny of headline growth figures, unadjusted for demographics, contributes to this. For example, it is not remarked often enough that, in terms of its working age population, Japan’s growth has outpaced that of many of its advanced economy peers, not least the United States. On that basis, in 2000–07, Japan grew at a cumulative rate of 15%, almost twice as fast as the United States (8%) – the reverse of what headline growth rates show (10% and 18%). The difference is even bigger if the post-crisis years are also considered.
Did you know that? The Japanese economy has been doing just fine. And the US has bigger issues than Japan when it comes to productivity growth. Focussing only on headline growth figures generates all sorts of sub-optimal decision making. We try to fix problems that don’t actually exist and paper over the ones that do.
Changing the way we report GDP has to be the simplest fix imaginable. And it’s going to become increasingly important as the rest of the world experiences the same demographic trends currently prevalent in Japan.
Some of the changes needed to spur the global economy are nigh on impossible politically. How about starting with the easy stuff?
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