There have been two schools of thought in the history of economics; Keynesian and Monetarism. The former rests on the belief that government actions can determine growth in the economy, spending money on say infrastructure projects when demand is slack and reining back once the economy picks up. Monetarism on the other hand believes the amount of money in the economy determines activity and in particular inflation. Should a government print too much money inflation will rise, control the creation of money and a government can control inflation.
In recent years however we’ve witnessed Quantitative Easing (QE); the large scale printing of money by a number of central banks. For example the Bank of England has initiated £435bn of QE and yet why hasn’t the UK achieved its target of 2% inflation? (CPI was stubbornly low at 0.6% in July 16). The answer is that the money injected into the economy, has rarely circulated beyond banks and pension providers and thus critics argue has only served to inflate asset prices.
Another novel idea has been the introduction of a Negative Interest Rate Policy (NIRP). An unconventional theory whereby nominal interest rates are set with a negative value, thereby imposing a cost on depositing money with banks, which therefore should increase spending? Unfortunately, efforts within Denmark and Sweden in 2010 and 2012, as well as by the ECB in 2014, have shown this policy appears to be ineffective as investors instead switch to hoarding cash by other means, such as safes or safety deposit boxes, which only leads to increased crime!
Given the above policies have only generated lack lustre growth many are now talking about Keynesian economics, which focuses on aggregate demand and theorises that you can increase economic output in the short run by increasing consumer spending, corporate investment or government spending. In effect, this is a loosening of fiscal policy, either via increasing spending or through reduced taxation which has to be funded through another source.
If the government is facing annual deficits and mounting debts (especially since the bailouts of banks in 2008/09), then how can you afford to loosen fiscal policy?
The answer, rather bizarrely may actually lie in the combination of both fiscal and monetary policy. In August 2016, the Bank of England announced an additional £10bn which is to be used to fund corporate debts which should boost employment and investments. The reality however is that corporates could just use lower debt rates to finance an increasing cash mountain or just return excess cash to share-holders. Is this any better than Government bonds?
A different approach could be to directly finance the UK consumer, who’s spending makes up the vast majority of output within the UK economy. Increasingly known as ‘helicopter money’, this concept was originally proposed in 1969 by Milton Friedman and rather than relying on these funds to ‘trickle down’ from banks or corporates, the BoE could instead just ‘drop’ money on the UK consumer (hence the helicopter reference) or use monetary policy to reduce taxes.
Is this the future of monetary policy? In effect, the combination of both Monetarism and Keynesian could directly stimulate the country, but in doing so it would dramatically increase the quantity and circulation of money, which could raise inflation beyond the UK’s 2% target. This could potentially raise tricky questions for the Bank of England and isn’t this ultimately a political question?
When the future of central bank policy is unclear and markets are being driven by central banks, politics and currencies, it seems more important than ever to have a truly diversified portfolio to mitigate external shocks.
The above article by Andrew Gilbert, Investment Manager at Parmenion Investment Management, was first published by Parmenion Investment Management on 9th September 2016