Does cheap money mean governments care about the future?
The appeal of cheap money is hard to shake, but as governments persist with low interest rates it is time they explain the longer-term benefits
We have been living in a low interest rate world since the Great Recession of 2008-2009. While the United States has pulled back slightly on quantitative easing, macroeconomic policy in various guises continues in the opposite direction in Japan, the euro zone, Britain and China. It is unlikely that cheap money will go away soon.
Opinion is divided on how sensible it is to rely on expansionist policies that facilitate cheap money, easy credit and low interest rates. Those doubting the wisdom of stimulus policies worry about asset bubbles, debt-fuelled growth and an accompanying reluctance to embrace the structural adjustments needed to spark improvements in productivity.
What the critics fear is an irreversible addiction to procrastination that will eventually lead to crisis. For a large number of countries, structural reforms to improve productivity are crucial to future prosperity.
The other side of the argument thinks in terms of Keynesian countercyclical action and the avoidance of needless austerity. It has worked before. Why would it not work again? Deflation can be as toxic as inflation.
These opposing views cannot be readily reconciled. The concerns are valid on both sides. Everything depends on time, place and the intensity with which a chosen stance is pursued. And, of course, considerable risks are attached to both stimulus and austerity.
But as my friend Richard Ward of HSBC and I were discussing recently, these arguments ignore a fundamental question that carries with it the makings of an interesting paradox. We commonly associate interest rates with time preference. The higher the interest rate, the greater the value assigned to the present in relation to the future. Low interest rates imply the reverse.
If the future were as highly valued as the present by our banks, they would extend us interest-free loans. They would be saying money has the same value in the future as it has today. That we can only dream of. Monetary institutions could, of course, still prosper the Islamic banking way, where interest is considered usury and equity partnership is the form that credit takes.
Many other thought experiments point in the same direction, and account for why money is deemed to be worth more today than tomorrow, including after inflation has been taken into account. Preference for the present over the future suggests we are more attuned to near-term gratification than to the welfare of the unborn. Hence we embrace a positive discount rate.
The instant gratification argument might be made to sound less avaricious or indulgent if uncertainty is introduced into the argument. It could be said that uncertainty about the future inhibits investment in the future.
Why make sacrifices in foregone satisfaction if you cannot be sure that all the necessary circumstances will be present for the sacrifice to be rewarded? Some might argue the opposite. Precisely because there is uncertainty about the future, people's natural aversion to risk might argue for greater caution (less consumption today) under uncertainty. These are complicated issues. The climate change debate brings them to the fore. Disagreements have arisen over what is essentially an ethical value - the pure time preference reflected in the discount rate.
One side of the argument says that market interest rates are a reasonable reflection of society's pure time preference, demonstrating that we care more about the present than the future. This is presented as a collective social preference.
The other side asserts the discount rate should approximate zero. That implies we have no right to compromise the welfare of the unborn, as they do not yet have a voice. The future should be considered as important as the present. The difference between these two positions is stark.
This brings us back to the core question. That is, what to make of the persistence of a near-zero interest rate world. Is it that governments are implicitly taking care of the future by running low interest rate regimes? Or are they simply postponing needed productivity-enhancing economic adjustment to make life easier for the population?
A strategy of postponement is more likely to serve the electoral cycle or regime survival than to prepare the way for a prosperous future. On the other hand, austerity can lead to a downward spiral of deflationary stasis.
Unfortunately for governments bent upon blame and responsibility avoidance, there is no such thing as policy neutrality. Any stance on the part of governments - interventionist or otherwise - implicitly reflects an inter-temporal welfare preference.
Governments ought to be able to explain what, if anything, a low interest rate regime promises in terms of future well-being.
Patrick Low is vice-president of research at the Fung Global Institute