Stuart Trow: Seeing the investment light

28 Nov 2019

Stuart Trow, a credit strategist at the European Bank for Reconstruction & Development

At long last, people are starting to talk about sensible policy alternatives to the mindless monetary orthodoxy of the global central banks.

Monetary policy is a valuable stimulus tool. But it works in much the same way as an adrenaline shot. It’s great for reviving the patient but is hardly a long-term treatment plan.

The Fisher hypothesis essentially has it that monetary actions will have no effect on the real economy over the longer term. Yet the broader impact of monetary easing is not so benign. Whatever the effect on the real economy, there is no doubt that asset prices do respond to cuts in nominal interest rates.

Moreover, low nominal rates bestow their benefits unevenly across the economy. They disproportionately favour those who are already asset rich or have sufficient income to be granted loans at favourable rates. These people generally have extremely low marginal propensities to consume.

Once expectations of low nominal rates become embedded, people tend to eschew traditional investment in the real economy in favour of financial assets, such as securities and real estate, that offer a capital gain.

That is why, for example, positive convexity, long-term bonds are so attractive, despite the minimal yields on offer. Austria’s infamous 2117 “century bond” may carry a coupon of just 2.1% and yield a mere 99 bps, but in August it traded as high as €214 having been issued at par less than two years earlier.

Yet for all this monetary accommodation, the ECB also played fiscal hardball.

Indeed, its blunt fiscal controls led to a degree of austerity that would have made even former UK Chancellor George Osborne blush.

So given the failure of monetary easing and fiscal austerity to do anything other than distort asset markets and depress growth, why don’t we simply let governments spend? The answer is that, unless you are very careful, the impact of fiscal stimulus just ends up being as temporary as the monetary kind.

There are though signs of emerging enlightenment. Amid weak macroeconomic data, the German government is discussing plans to set up independent public investment agencies. These will capitalise on current low interest rates by investing in public infrastructure and climate protection measures outside the restrictive straight jacket of national spending rules.

This so-called “shadow budget” would barely scratch the surface though. The German state-owned development bank KfW estimates that the pent-up demand for public investment in Germany is some €138bn (£118bn). Nevertheless, this would be an important first step in acknowledging the need for genuine state investment.

In Europe, though, there is a further problem. We have industries that were world leaders a few decades ago but have been somewhat overtaken in recent years. As a community we desperately need investment to step up to the next level to compete globally. If we don’t, Germany’s slowdown might simply be a foretaste of the stagnation to come.

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