HH Central Banks See No Way Out Of The Low Interest Rate Trap

Figure 3: Marginal Productivity of Capital of US, Japan, and Germany

(Click on image to enlarge)


Source: AMECO. Marginal productivity of capital defined as the absolute change of real output compared to the previous year divided by real investment of the current year.

This evidence strongly supports the view that economic agents have adapted to the low-rate environment created by the central banks (and not the central banks to an environment of “naturally” low rates). One consequence of this is that inefficient firms are kept alive artificially. Based on firm-level data from fourteen advanced economies, Ryan Banerjee and Boris Hofmann find a rise in the share of zombie firms, defined as unprofitable firms with low stock market valuations, from 4 percent in the late 1980s to 15 percent in 2017.7 This implies that central banks have contributed to the low-growth environment by impeding productivity gains. Moreover, in attempts to reanimate growth, government debt has increased to levels last seen in times of major wars (see figure 4). As a result of the adaptation of economic agents, an exit from the low-rate environment most likely would be accompanied by major financial and economic disruptions. The last time a major central bank knowingly took the risk of disruption for the sake of ending a low-rate policy occurred in Japan in the late 1980s. Since then, no central banker has wanted to repeat this unhappy experience.

Figure 4: Public Debt Ratios


Source: OECD Economic Outlook.

This leaves us with a quite skeptical outlook for the credit money system. Inflation is likely to get out of control and money will probably need to be re-anchored one way or another. Central bank digital money could help to achieve this and preempt a monetary crash.8 But central bankers are probably too risk-averse to try experimental therapy even in the face of death.

1.Alvin Hansen, "Economic Stagnation and Population Growth," American Economic Review 29, no. 1 (1939): 1-15; Lawrence H. Summers, "U.S. Economic Prospects: Secular Stagnation, Hysteresis, and the Zero Lower Bound," Business Economics 49, 2 (2014): 65–73; and Robert Gordon, "Is US Economic Growth Over? Faltering Innovation Confronts the Six Headwinds" (NBER Working Paper No. 18315, 2012).

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Beating Buffett 2 months ago Member's comment

Good read, thanks.