Monetary Policy after the Great Recession: The Role of Interest Rates
Monetary Policy after the Great Recession: The Role of Interest Rates
New York: Routledge, 2020, xviii 230 pp.
Nikolay Gertchev ([email protected]) holds a PhD in economics from the University of Paris 2 Panthéon-Assas and currently lives in Belgium, where he works for an international organization.
In his second book, Arkadiusz Sieron, Assistant Professor at the University of Wroclaw, embarks on an ambitious task: to investigate the failure of expansionary monetary policy to address the challenges of the 2008–09 Great Recession. An introduction, seven chapters and a final synopsis make up the main body of a text that spreads over 168 pages. Two short six-page appendices comment upon the likely future course of monetary policy and on the fitness of interest-rate cuts to respond to the COVID-19 crisis. An impressive forty-page bibliography, or about six hundred references, and a ten-page index close the book.
The first chapter examines the conventional “interest rate” channel of monetary policy. Sieron shows that it was ineffective to spur economic growth after the Great Recession and attributes its unsuccessfulness to the failure of lower policy rates to revive bank credit. In his assessment, factors such as borrowers’ debt overhang and lenders’ impaired balance sheets explain why central banks, despite lowering their policy rate aggressively, could not fuel the credit expansion that would have revived the economy: “In other words, there is no mechanical link between monetary policy and the supply of loans and thus economic growth.” (p. 22; our emphasis)
The second chapter focuses on the newer “portfolio” channel of quantitative easing. It offers a high-level theoretical discussion, rather than a detailed context-based presentation of the specific asset purchases by the major central banks. That discussion is focused on the wealth effect and concludes that, thanks to these non-conventional interventions, monetary policy remains potent despite the zero lower bound, even though its potency is limited to effects of redistribution: “Keynesians are wrong, while monetarists are right: monetary policy does not become totally powerless when interest rates reach the zero lower bound. It affects the economy through the relative prices of assets, goods, and services.” (p. 39)
The next two chapters explore, in further detail, some of the consequences of expansionary monetary policy. The third chapter discusses how a low policy rate encourages risk-taking, because of the relatively higher monetary attractiveness of risky assets (search for yield) and a stronger tolerance for higher risk: “In normal times, risk is seen as something negative, and individuals try to avoid it if possible. However, in an environment of very low interest rates, risk becomes more desirable and worth seeking” (p. 60). The fourth chapter deals with the monetary policy-driven resource misallocation through the prism of the theory and empirics of “zombification.”
In the remainder of the book, Sieron offers his ideas on the broader aspects of monetary policy. The fifth chapter argues that, when setting their policy rates, central banks should not target the economy’s neutral interest rate. Their own actions lower that neutral rate, which makes the target endogenously dependent and hence never achievable. Within a Wicksell-inspired analytical framework, Sieron rejects the secular stagnation hypothesis and privileges the financial-drag assumption in explaining the post-crisis economic slowdown. He draws some normative implications:
So there is no such thing as a neutral-interest rate policy. The central banks should thus stop setting interest rates if they are unable to get them aligned with the natural interest rates and allow markets to freely set interest rates. Or, given that the neutral interest rate is endogenous to the monetary policy it is supposed to guide, it should not serve at least as a policy benchmark. (p. 110; our emphases)
The sixth chapter reviews the impact of the negative interest rates policies conducted by some central banks in recent years, particularly as regards reduced profitability of commercial banks and negative yields on government bonds. It concludes,
…there is a lack of satisfactory theory explaining how charging for the excess reserves of commercial banks held at central banks—some economists even call it “a tax on reserves”—is supposed to revive bank lending and then the overall economy. The banking system itself cannot decrease the amount of reserves through granting loans.” (p. 133; our emphasis).
The last, seventh, chapter documents and discusses the rise in overall indebtedness of corporations, households and governments. Particular emphasis is put on the self-reinforcing loop between indebtedness and expansionary monetary policy, leading to higher asset prices, which—because the assets are used as required collateral for loans—inflates creditworthiness and supports further indebtedness. The analysis points out that, beyond a certain level, debt accumulation becomes a drag on economic growth:
Used wisely and in moderation, it [debt] can improve welfare, but when used imprudently and in excess, the result can be disastrous. I showed that although an increase in household debt can reflect financial deepening, in an environment of ultralow interest rates it may rather indicate a build-up of financial imbalances. (p. 159; our emphasis)
This very sketchy overview can only hint at Sieron’s extremely ambitious project to expand economists’ understanding of interest rates and monetary policy. The result is a widely researched text that overwhelms the reader with a multitude of conceptual and bibliographical references. This makes it a useful collection of references for economists interested in contemporary monetary topics. Sieron is not shy about his achievement: “I am not aware of another book that would so thoroughly and completely analyse the issues related to the interest rates in the conduct of monetary policy” (p. 3).1 Regardless of any merits of that claim, it would have been preferable to let the readers and posterity indulge in the praising of this work.2 Yet, such a statement only begs a few immediate questions. What type of approach does the analysis follow? Does it lead to rock-solid and original conclusions that build upon existing knowledge as part of a consistent analytical framework? In what sense is it thorough and complete?3 The remainder of this review will quickly show some of the pitfalls of the approach Sieron has chosen to follow.
The best way to describe that approach is to call it eclectic ecumenism. The book clearly aims at reaching the largest possible audience. To achieve that, the author has made the choice to address all economists, whatever their foundational premises. In practice, this boils down to applying some Austrian insights to a large corpus of other intellectual universes. As a result, the reader will not find a fully established single theoretical framework of any intellectual affiliation. The following passage, which introduces a discussion on the implications of debt, is very revealing of the eclectic ecumenism approach:
Credit creation has been the basis of the Austrian business cycle theory since Mises’s ( 1953) Theory of Money and Credit. Fisher (1933) formulates a debt-deflation theory of the Great Depression. Minsky (1992) develops a financial-instability hypothesis according to which endogenously rising leverage in good times paves the way for crisis. Koo (2013) argues that a balance sheet recession and debt overhang […].” (p. 144)
This compilation of different theoretical views, not always in mutual agreement, is characteristic of Sieron’s entire book and results in a lack of consistency. This unfortunate outcome is not helpful to the author who wants to “argue that we should blame wrong economic theories and monetary policies based on them” for the slow recovery from the Great Recession. (p. 1) Would one not need a carefully crafted theory to refute other theories step-by-step? Moreover, because of the lack of consistent framework, his analysis leads to unsubstantiated and ultimately unsound conclusions, instead of providing convincing answers.
Take for instance Sieron’s analysis of the ineffective interest rate channel. The argument boils down to claiming that monetary policy fails to contribute to economic growth in downturns only, because—in the bust—some factors, such as borrowers’ deleveraging and lenders’ rest
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