This past year or so has seen a massive creation of liquidity across the world as Central Banks ramped up their Quantitative easing programes and Governments threw money into the mix in an attempt to revive economic momentum, inflation and preserve the unstable financial system. There is of course no simple way back, and currently the main impact appears to be asset inflation across stocks and property, while the real economy languishes, even as debt climbs.
But now the IMF wants to join the FIAT party – FIAT meaning “Let it Be” or created from nothing using allocating special drawing rights (SDR) to augment instantaneously the international reserves of its members. They claim this would significantly benefit poorer countries and help build confidence at a time of global crisis, dramatically demonstrating international cooperation. But it is pure Neo-liberalism…
CONTENTS 0:00 Start 0:40 Introduction 1:16 IMF Joins the Fiat Party 2:00 Special Drawing Rights 3:12 IMF Statement $650 Billion SDR Allocation 10:20 The History of SDR’s And How They Work 21:35 PRGT Australia Contributes $500 million 22:05 SDR Accounting 24:50 Pros and Cons 27:22 My Conclusions
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"Lets Create Yet More Money": Says The IMF [Podcast]
This past year or so has seen a massive creation of liquidity across the world as Central Banks ramped up their Quantitative easing programes and Governments threw money into the mix in an attempt to revive economic momentum, inflation and preserve the unstable financial system. There is of course no simple way back, and currently the main impact appears to be asset inflation across stocks and property, while the real economy languishes, even as debt climbs.
But now the IMF wants to join the FIAT party – FIAT meaning “Let it Be” or created from nothing using allocating special drawing rights (SDR) to augment instantaneously the international reserves of its members. They claim this would significantly benefit poorer countries and help build confidence at a time of global crisis, dramatically demonstrating international cooperation. But it is pure Neo-liberalism…
CONTENTS 0:00 Start 0:40 Introduction 1:16 IMF Joins the Fiat Party 2:00 Special Drawing Rights 3:12 IMF Statement $650 Billion SDR Allocation 10:20 The History of SDR’s And How They Work 21:35 PRGT Australia Contributes $500 million 22:05 SDR Accounting 24:50 Pros and Cons 27:22 My Conclusions
International Monetary Fund Managing Director Kristalina Georgieva made the following statement today following a conference call of G20 Finance Ministers and Central Bank Governors:
“The human costs of the Coronavirus pandemic are already
immeasurable and all countries need to work together to protect people and
limit the economic damage. This is a moment for solidarity—which was a major
theme of the meeting today of the G20 Finance Ministers and Central Bank
Governors.
“I emphasized three points in particular:
“First, the outlook for global growth: for 2020 it is negative—a recession at least as bad as during the global financial crisis or worse. But we expect recovery in 2021. To get there, it is paramount to prioritize containment and strengthen health systems—everywhere. The economic impact is and will be severe, but the faster the virus stops, the quicker and stronger the recovery will be.
“We strongly support the extraordinary fiscal actions many
countries have already taken to boost health systems and protect affected
workers and firms. We welcome the moves of major central banks to ease monetary
policy. These bold efforts are not only in the interest of each country, but of
the global economy as a whole. Even more will be needed, especially on the
fiscal front.
“Second, advanced economies are generally in a better
position to respond to the crisis, but many emerging markets and low-income
countries face significant challenges. They are badly affected by outward
capital flows, and domestic activity will be severely impacted as countries
respond to the epidemic. Investors have already removed US$83 billion from
emerging markets since the beginning of the crisis, the largest capital outflow
ever recorded. We are particularly concerned about low-income countries in debt
distress—an issue on which we are working closely with the World Bank.
“Third, what can we, the IMF, do to support our members?
We are concentrating bilateral and multilateral surveillance on this crisis and policy actions to temper its impact.
We will massively step up emergency finance—nearly 80 countries are requesting our help—and we are working closely with the other international financial institutions to provide a strong coordinated response.
We are replenishing the Catastrophe Containment and Relief Trust to help the poorest countries. We welcome the pledges already made and call on others to join.
We stand ready to deploy all our US$1 trillion lending capacity.
And we are looking at other available options. Several low- and middle-income countries have asked the IMF to make an SDR allocation, as we did during the Global Financial Crisis, and we are exploring this option with our membership.
Major central banks have initiated bilateral swap lines with emerging market countries. As a global liquidity crunch takes hold, we need members to provide additional swap lines. Again, we will be exploring with our Executive Board and membership a possible proposal that would help facilitate a broader network of swap lines, including through an IMF-swap type facility.
“These are extraordinary circumstances. Many countries are
already taking unprecedented measures. We at the IMF, working with all our
member countries, will do the same. Let us stand together through this
emergency to support all people across the world.”
We look at the latest trends on Australian Bonds, Credit Markets and the recent IMF paper on negative interest rates – which they link to the need to restrict cash. This will not end well.
We look at the latest trends on Australian Bonds, Credit Markets and the recent IMF paper on negative interest rates – which they link to the need to restrict cash. This will not end well.
Hot off the press – How Can Interest Rates Be Negative? – we get the latest missive from the IMF which confirms precisely what we have been saying.
But the concern remains about the limits to negative interest rate policies so long as cash exists as an alternative.
Here is the article. Read, and weep….
Money has been around for a long time. And we have always
paid for using someone else’s money or savings. The charge for doing this is
known by many different words, from prayog in ancient Sanskrit to interest in
modern English. The oldest known example of an institutionalized, legal
interest rate is found in the Laws of Eshnunna, an ancient Babylonian text
dating back to about 2000 BC.
For most of history, nominal interest rates—stated rates
that borrowers pay on a loan—have been positive, that is, greater than zero.
However, consider what happens when the rate of inflation exceeds the return on
savings or loans. When inflation is 3 percent, and the interest rate on a loan
is 2 percent, the lender’s return after inflation is less than zero. In such a
situation, we say the real interest rate—the nominal rate minus the rate of
inflation—is negative.
In modern times, central banks have charged a positive
nominal interest rate when lending out short-term funds to regulate the
business cycle. However, in recent years, an increasing number of central banks
have resorted to low-rate policies. Several, including the European Central
Bank and the central banks of Denmark, Japan, Sweden, and Switzerland, have
started experimenting with negative interest rates —essentially making banks
pay to park their excess cash at the central bank. The aim is to encourage
banks to lend out those funds instead, thereby countering the weak growth that
persisted after the 2008 global financial crisis. For many, the world was
turned upside down: Savers would now earn a negative return, while borrowers
get paid to borrow money? It is not that simple.
Simply put, interest is the cost of credit or the cost of
money. It is the amount a borrower agrees to pay to compensate a lender for using
her money and to account for the associated risks. Economic theories
underpinning interest rates vary, some pointing to interactions between the
supply of savings and the demand for investment and others to the balance
between money supply and demand. According to these theories, interest rates
must be positive to motivate saving, and investors demand progressively higher
interest rates the longer money is borrowed to compensate for the heightened
risk involved in tying up their money longer. Hence, under normal
circumstances, interest rates would be positive, and the longer the term, the
higher the interest rate would have to be. Moreover, to know what an investment
effectively yields or what a loan costs, it important to account for inflation,
the rate at which money loses value. Expectations of inflation are therefore a
key driver of longer-term interest rates.
While there are many different interest rates in financial
markets, the policy interest rate set by a country’s central bank provides the
key benchmark for borrowing costs in the country’s economy. Central banks vary
the policy rate in response to changes in the economic cycle and to steer the
country’s economy by influencing many different (mainly short-term) interest
rates. Higher policy rates provide incentives for saving, while lower rates
motivate consumption and reduce the cost of business investment. A guidepost
for central bankers in setting the policy rate is the concept of the neutral
rate of interest : the long-term interest rate that is consistent with stable
inflation. The neutral interest rate neither stimulates nor restrains economic
growth. When interest rates are lower than the neutral rate, monetary policy is
expansionary, and when they are higher, it is contractionary.
Today, there is broad agreement that, in many countries,
this neutral interest rate has been on a clear downward trend for decades and
is probably lower than previously assumed. But the drivers of this decline are
not well understood. Some have emphasized the role of factors like long-term
demographic trends (especially the aging societies in advanced economies), weak
productivity growth, and the shortage of safe assets. Separately, persistently
low inflation in advanced economies, often significantly below their targets or
long-term averages, appears to have lowered markets’ long-term inflation
expectations. The combination of these factors likely explains the striking
situation in today’s bond markets: not only have long-term interest rates
fallen, but in many countries, they are now negative.
Returning to monetary policy, following the global financial
crisis, central banks cut nominal interest rates aggressively, in many cases to
zero or close to zero. We call this the zero lower bound, a point below which
some believed that interest rates could not go. But monetary policy affects an
economy through similar mechanics both above and below zero. Indeed, negative
interest rates also give consumers and businesses an incentive to spend or
invest money rather than leave it in their bank accounts, where the value would
be eroded by inflation. Overall, these aggressively low interest rates have
probably helped somewhat, where implemented, in stimulating economic activity,
though there remain uncertainties about side effects and risks.
A first concern with negative rates is their potential
impact on bank profitability. Banks perform a key function by matching savings
to useful projects that generate a high rate of return. In turn, they earn a
spread, the difference between what they pay savers (depositors) and what they
charge on the loans they make. When central banks lower their policy rates, the
general tendency is for this spread to be reduced, as overall lending and
longer-term interest rates tend to fall. When rates go below zero, banks may be
reluctant to pass on the negative interest rates to their depositors by
charging fees on their savings for fear that they will withdraw their deposits.
If banks refrain from negative rates on deposits, this could in principle turn
the lending spread negative, because the return on a loan would not cover the
cost of holding deposits. This could in turn lower bank profitability and
undermine financial system stability.
A second concern with negative interest rates on bank deposits
is that they would give savers an incentive to switch out of deposits into
holding cash. After all, it is not possible to reduce cash’s face value (though
some have proposed getting rid of cash altogether to make deeply negative rates
feasible when needed). Hence there has been a concern that negative rates could
reach a tipping point beyond which savers would flood out of banks and park
their money in cash outside the banking system. We don’t know for sure where
such an effective lower bound on interest rates is. In some scenarios, going
below this lower bound could undermine financial system liquidity and
stability.
In practice, banks can charge other fees to recoup costs,
and rates have not gotten negative enough for banks to try to pass on negative
rates to small depositors (larger depositors have accepted some negative rates
for the convenience of holding money in banks). But the concern remains about
the limits to negative interest rate policies so long as cash exists as an
alternative.
Overall, a low neutral rate implies that short-term interest rates could more frequently hit the zero lower bound and remain there for extended periods of time. As this occurs, central banks may increasingly need to resort to what were previously thought of as unconventional policies, including negative policy interest rates.
No, central banks are taking us down a blind alley!
The IMF just released a working paper* “Debt Is Not Free“. The evidence presented in this paper points to the risks, suggesting that public debt might not be free after all! In addition, low, or ultra low interest rates are not a get out of jail card!
The case for more public debt is being reinforced by weak economic activity across the globe, large investment needs, and increasing concerns that monetary policy may be reaching its limits particularly in advanced economies. And yet, the risk of fiscal crises still casts a long shadow. Therefore, as many countries remain riddled with mounting debt, one of the most pressing questions facing policymakers is whether current high debt levels are a bellwether of future crises with large economic costs.
The argument that “public debt may have no fiscal cost”is also gaining traction as many countries face historically low interest rates and the global stock of negative-yielding debt is hovering around $12 trillion by the end of 2019. The underlying rationale is that if interest rates are lower than the economic growth rate—that is, the interest-growth differential is negative—there is no reason to maintain a primary surplus as it would be feasible to issue debt without later increasing taxes.
This working paper contributes to the debate on the costs of public debt by revisiting its importance in predicting fiscal crises. In a world of ultra-low interest rates, it is tempting to believe that there may be no costs. For those that subscribe to that theory, the natural conclusion is that now may be the time to rely more heavily on debt to attend to worthy causes such as fixing a crumbling infrastructure all while propping up a frail economy. The skeptics point to history, noting that those that ignore high debt do it at their peril as excessive debt may force disruptive fiscal adjustments or eventually lead to costly crises.
They use machine learning models to confront these dueling views with evidence. Our results show that public debt in its various forms is the most important predictor of fiscal crises and it does matter always and everywhere. But public debt is not the only game in town as its interactions with other predictors also make a difference. Surprisingly, however, the interest-growth differential does not have much signaling value: it does not really matter whether it is highly positive or negative; moreover, beyond certain debt levels, the likelihood of a crisis surges regardless.
It is important to acknowledge that the machine learning techniques used do not allow us to establish causality. This is an area where computational science is still trying to make inroads. What they can confidently say is that there is a high correlation between public debt and crises and that this association is very robust. Therefore, at the current juncture, complacency about high debt levels would be ill-advised even if interest-growth differentials were to remain low. The underlying reason is that the dynamics of crises are highly non-linear and by the time the interest-growth differential may start flashing red, a crisis may well be underway catching policymakers off guard.
These findings do not mean that bringing debt down is always the right policy prescription. There are clearly cases where the use of debt for countercyclical purposes, to increase public investment, or to address other structural needs is desirable. However, the evidence presented in this paper points to the risks, suggesting that public debt might not be free after all!
*IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
The IMF published their latest preliminary findings at the end of an official IMF staff visit (or ‘mission’) to Australia. They recommend preparing for risk from a rapid housing credit upswing, by introducing loan-to-value and debt-to-income limits, and possibly a sectoral countercyclical capital buffer targeting housing exposures. Plus transitioning from a housing transfer stamp duty to a general land tax to improve efficiency by easing entry into the housing market and promoting labor mobility, while providing a more stable revenue source for the States. Such reforms could be complemented by reducing structural incentives for leveraged investment by households, including in residential real estate.
Economic growth has gradually improved
from the lows in the second half of 2018 but has remained below
potential.
Growth has been supported by public spending, including on infrastructure,
and net exports, which have held up well despite headwinds from global
policy uncertainty and China’s economic slowdown. However, domestic private
demand has remained weak amid subdued confidence, with a widening output
gap. In addition, the ongoing drought has been a drag on economic growth.
Wage growth has remained sluggish, reflecting persistent labor market
slack, and inflation and measures of inflation expectations have dropped to
below Australia’s 2 to 3 percent target range. Following a marked
adjustment over the past two years, housing prices have started to recover,
particularly in Sydney and Melbourne.
Growth should continue to recover at a gradual pace.
Following growth of about 1.8 percent in 2019, the economy is expected to
expand by 2.2 percent in 2020.Private domestic demand is
expected to recover slowly, supported by monetary policy easing and the
personal income tax cuts. An incipient recovery in mining investment is
also expected to contribute to growth. In addition, the house price
recovery will likely reduce the drag on consumption from earlier, negative
wealth effects. That said, residential and non-mining business investment
are expected to take longer to recover. Over the medium term, growth is
expected to reach the mission’s estimate of potential growth of about 2½
percent, supported by infrastructure spending and structural reforms. With
continued labor market slack, underlying inflation will likely stay below
the target range until 2021.
Risks to the outlook remain tilted to the downside.
· On the external side, Australia is especially exposed to a
deeper-than-expected downturn in China through exports of commodities and
services. A renewed escalation of U.S.-China trade tensions could further
impair global business sentiment, discouraging investment in Australia. A
sharp tightening of global financial conditions could squeeze Australian
banks’ wholesale funding and raise borrowing costs in the economy.
· On the domestic side, private consumption could be weaker should a
cooling in labor markets squeeze household income. Adverse weather
conditions, including a more-severe-than-expected drought, could further
disrupt agriculture, dampening growth. On the upside, looser financial
conditions could re-accelerate asset price inflation, boosting private
consumption but also adding to medium-term vulnerabilities given high
household debt levels.
With below-potential growth, weakening inflation expectations, and
continued downside risks, the macroeconomic policy mix should remain
accommodative.
· Monetary policy has been appropriately accommodative, and continued
data-dependent easing will be helpful to support employment growth,
inflation and inflation expectations.
· The consolidated fiscal stance is appropriately expansionary for
FY2019/20. Fiscal policy will be supportive for demand via reductions in
personal income and small business corporate taxes, additional
infrastructure spending, and the government’s announced support measures
for small- and medium-sized enterprises (SMEs). However, fiscal policy
aggregated across all levels of government will be contractionary in
FY2020/21, as state-level infrastructure investment is expected to decline.[1] States should reconsider this and attempt to at least maintain their
current level of infrastructure spending as a share of GDP to continue
addressing infrastructure gaps and supporting aggregate demand.
The authorities should be ready for a coordinated response if downside
risks materialize.
Australia has substantial fiscal space it can use if needed. In addition to
letting automatic stabilizers operate, Commonwealth and state governments
should be prepared to enact temporary measures such as buttressing
infrastructure spending, including maintenance, and introducing tax breaks
for SMEs, bonuses for retraining and education, or cash transfers to
households. In case stimulus is necessary, the implementation of budget
repair should be delayed, as permitted under the Commonwealth government’s
medium-term fiscal strategy. In addition, unconventional monetary policy
measures such as quantitative easing may become necessary in such a
scenario as the cash rate is already close to the effective lower bound.
The macroprudential policy stance remains appropriate but should stand
ready to tighten in case of increasing financial risks.
Australian banks remain adequately capitalized and profitable, but
vulnerable to high exposure to residential mortgage lending and dependent
on wholesale funding. While the risk structure of mortgage loans has been
significantly improved, renewed overheating of housing markets and a fast
pick-up in mortgage lending remain risks in a low-interest-rate
environment. The Australian Prudential Regulation Authority (APRA) should
continue to expand and improve the readiness of the macroprudential
toolkit. This should include preparations, for potential use in the event
of a rapid housing credit upswing, for introducing loan-to-value and
debt-to-income limits, and possibly a sectoral countercyclical capital
buffer targeting housing exposures.
Strong reform efforts to bolster the resilience of the financial sector
should continue.
The mission supports the authorities’ plan to further enhance banks’
capital framework, including strengthening their loss-absorbing capacity
and resilience. In addition, encouraging banks to further lengthen the
maturity structure of their wholesale funding would help mitigate ongoing
structural liquidity risks. The authorities’ commitment to implement the
recommendations made by the Hayne Royal Commission by end-2020 is welcome.
The improvement in lending standards further enhances financial sector
resilience, and reducing the uncertainty in the enforcement of responsible
lending obligations would prevent excessive risk aversion in the provision
of credit. The authorities should implement the APRA Capability Review’s
recommendations to strengthen APRA’s resources and operational flexibility,
enhance its supervisory approach in assessing banks’ governance and risk
culture, and strengthen enforcement efforts. In addition, reinforcing
financial crisis management arrangements and strengthening the AML/CFT
regime should remain priorities, in line with the findings of the 2018
Financial Sector Assessment Program (FSAP).
Housing supply reforms remain critical for restoring affordability.
More efficient long-term planning, zoning, and local government reform that
promote housing supply growth, along with a particular focus on
infrastructure development, including through “City Deals”, should help
meet growing demand for housing.
Efforts to boost private investment and innovation should be stepped
up.
Non-mining business investment, including R&D, has been sluggish,
contributing to lower productivity growth. Reducing domestic policy
uncertainty, supporting SMEs’ access to finance, and accelerating
structural reforms would help to improve the investment environment.
Building on reforms in the 2015 Harper Review, Australia can further
improve product market regulations, including by simplifying business
processes through the work of the Deregulation Taskforce. The ongoing
policy priority on skills and education reforms is welcome to improve the
environment for innovation, and consideration should be given to faster
implementation of the recommended measures in the Australia 2030: Prosperity through Innovation report. Government
initiatives to relieve SME financing constraints are welcome, including the
Australian Business Securitization Fund and the Australian Business Growth
Fund. Incentives for banks to lend more to businesses, including through
reducing the concentration in mortgages, can help support business
investment, as can the promotion of venture capital. Supporting new
investment through tax measures, possibly including targeted investment
allowances, as well as further improving the effectiveness of government
R&D support for younger firms, would also be helpful.
Australia’s continued efforts supporting international cooperation are
welcome.
The mission welcomes the authorities’ support to enhance the effectiveness
of the WTO and pursuit of the Regional Comprehensive Economic Partnership
(RCEP), which aims to liberalize trade and improve quality and
environmental standards and labor mobility throughout the Asia and Pacific
region. Developing a national, integrated approach to energy policy and
climate change mitigation, and clarifying how existing and new instruments
can be employed to meet the Paris Agreement goals, would help reduce policy
uncertainty and catalyze environmentally-friendly investment in the power
sector and the broader economy.
Further reforms can help to promote female labor market participation
and reduce youth underemployment.
There is scope to increase full-time employment for Australian women and
addressing persistently high underemployment particularly among youth. The
2018 Child Care Subsidy program and the forthcoming Mid-Career Checkpoint
program are expected to support women in work. This could lay the
foundation for a broader review of the combination of taxes, transfers, and
childcare support to reduce disincentives for female labor force
participation. Pursuing ongoing reforms in vocational training can help
reduce youth underemployment.
Broad fiscal reforms would help promote efficiency and inclusiveness.
Australia should continue to reduce distortions in its tax system to
promote economic efficiency and in doing so should be mindful of
distributional consequences considering income inequality. Recent reforms
in personal and corporate income taxes have helped to improve the
efficiency of the tax system. A further shift from direct to indirect taxes
could be made by broadening the goods and services tax (GST) base and
reducing the statutory corporate income tax rate for large firms. The
impact of these reforms could be made less regressive for households
through targeted cash transfers. Transitioning from a housing transfer
stamp duty to a general land tax would improve efficiency by easing entry
into the housing market and promoting labor mobility, while providing a
more stable revenue source for the States. Such reforms could be
complemented by reducing structural incentives for leveraged investment by
households, including in residential real estate.
The mission would like to thank the authorities and counterparts in the
private sector, think tanks, and other organizations for frank and
engaging discussions.
