Some of the factors limiting US growth also hold the key to its future says Steve Malin. This includes ineffective Fed policy, rising populism and transformative technology that policymakers and businesses must take notice of or risk missing the wave.
The Fed's faulty assumptions
Throughout most of the post-crisis period, the US Federal Reserve argued that the United States' weak economic growth, productivity and capital spending were caused mainly by insufficient aggregate demand. In response, the Fed implemented aggressive monetary accommodation to stimulate spending—and, for a while, it succeeded. However, GDP growth soon decelerated and business investment stayed subdued, which indicated that the economic theory the Fed relied upon had proved to be faulty.
Consequently, several Fed officials in 2016 wrote extensively about how structural changes in the US economy had been interacting with ultra-low interest rates and tougher regulations on banks to make interest rate targeting difficult, reduce the target level of policy rates and restrain real economic growth. Among their key findings:
- Precautionary savings rose, causing real consumption to not keep pace with real disposable income.
- Persistently low interest rates encouraged households to postpone consumption and build up precautionary savings.
- Regulations raised hurdle rates on prospective business investments.
- The mix of regulatory and economic policies encouraged capital spending outside the US rather than within it.
- Low interest rates encouraged corporate leverage—not to finance productive investment, but to finance share buybacks and dividend distributions.
- Federal Reserve ownership of Treasury securities removed collateral from the repo market used to finance day-to-day operations of businesses.
- Low interest rates strained pension funding.
- Mortgage financing became more difficult.
- Banks chose to restrict some forms of lending in order to protect their equity from potential loan losses.
The modern industrial revolution
The Fed's policies and unforeseen structural changes have not been the only factors causing sluggish US economic growth. Growing populist movements are set to at least partially shape a new wave of fiscal intervention into economies—and monetary policy must account for these new influences in the years ahead. These movements reflect a combination of globalization, technological changes, political stalemates and geopolitical crises that have resulted in lower inflation-adjusted incomes and widening of income and wealth disparities.
Moreover, the inexorable development, marketing and implementation of a range of new technologies have already reshaped how businesses are organized—and arguably altered every aspect of economic activity. This chain reaction of technological progression will continue to generate enormous upheaval and opportunity. Not only have modern technologies become disruptive, but they have reduced the need for material inputs, enabled production at a zero marginal cost, made the entirety of human knowledge accessible via the cloud, and made knowledge available to anyone in the world at virtually no cost. These are new technologies that now "crowd-in" knowledge and understanding instead of crowding it out.
Clearly, the pace of adoption of new technologies has never before been so pervasive and rapid. As a result, all households, businesses and governments must adapt to and change with this new, modern industrial revolution or else risk their economic and financial well-being, now and in the future. This has significant implications for the Fed and other central banks: Failing to master the implications of this industrial revolution will not only cause them to miss their policy targets, but push them toward setting the wrong targets.
Don't expect the European Central Bank to announce any major policy change at its January 19 meeting, says Franck Dixmier. While neither inflation nor job growth are strong enough to change course right now, the ECB may soon reach its limits.
We do not expect the European Central Bank (ECB) to change its monetary policy this week; by staying the course, the ECB will be able to confirm its engagement with bond markets and its long-term impact on them.
This strategy is being driven primarily by the weakness of underlying euro-zone inflation—which, at 0.9% according to the latest publications, remains far from the ECB's medium-term objective of 2%.
Furthermore, the positive growth dynamic evidenced by leading indicators is insufficient to change things significantly.
European job creation is too weak to drive wage increases and hence raise core inflation
In particular, job-creation numbers are too weak to generate any wage increases meaningful enough to sufficiently raise core inflation.
Against this backdrop, ECB President Mario Draghi's speech on January 19 must be seen in the light of the monetary-policy meeting that preceded it: We expect he will confirm the central bank's dovish bias and keep open the possibility of resorting to any and all options the situation might make necessary.
However, ECB policy is approaching its limits as time goes by. In our opinion, the threshold of holding more than 33% of a country's outstanding debt is one that the central bank will refuse to cross, but it is unlikely that 2017 will see the bank either taper or begin halting its asset-purchase program.