Rage against central banks is misdirected

The real problem is a declining natural rate of interest through demographic shifts and lower productivity growth

Robin Harding


Central banks can do little to peg interest rates off their course without creating ripple effects across the economy, as the US conservative economist Milton Friedman said © FT montage; Bloomberg


Rocketing house prices, zombie companies, rising inequality, a runaway stock market, struggling savers and even the outright destruction of capitalism — perhaps the only thing that does not get blamed on easy monetary policy from central banks is the weather.

There is little doubt that low interest rates caused some of these effects, some of these forces. But the mistake is to blame low rates on central banks. They have no other choice.

Various champions have set out to right the perceived wrongs caused by central banks. In May, the German constitutional court ruled that the European Central Bank had failed to apply a “proportionality” test to its bond purchase programmes, while Judy Shelton, US president Donald Trump’s nominee to the Federal Reserve board, questions whether a central bank should even be allowed to set interest rates.

“How can a dozen, slightly less than a dozen, people meeting eight times a year, decide what the cost of capital should be versus some kind of organically, market-supply determined rate?” she said in an interview with the Financial Times last year.

The curiosity of such complaints is the idea that central banks have the arbitrary power to set interest rates at whatever level they like.

In the short-run, that may be true. But over any reasonable period of time, central banks cannot fix interest rates and still keep control over prices. Far more than is commonly appreciated, central banks are servants of underlying trends in the economy, not their masters.

To blame monetary policy for rising house prices or growth in debt is to assume, mistakenly, that central banks had any alternative.

For more than a century, a central concept in economics has been the “natural rate of interest”, variously defined as the rate that balances savings and investment, the return on an extra dollar of capital investment, or the real interest rate consistent with price stability. The natural rate can, and does, move about.

A new invention may provoke an investment boom and move it up; a recession might move it down. But there is nothing a central bank can do to influence it. Something similar would exist even in a barter economy. The rate is, as Ms Shelton likes it, “organically, market-supply determined”.

What happens if the central bank tries to fix interest rates above or below this natural level? In his 1967 presidential address to the American Economic Association, the conservative economist Milton Friedman famously argued that central banks cannot use monetary policy to keep unemployment below its “natural rate”. But in the same speech, he was adamant that they cannot peg interest rates either.

If a central bank tried to hold interest rates down below their natural rate, then surging demand for credit would push prices up. “The monetary authority can make the market rate less than the natural rate only by inflation. It can make the market rate higher than the natural rate only by deflation,” Friedman said.

Speaking in the 1960s, Friedman was mainly concerned about the inflationary effects of postwar attempts to keep interest rates artificially low. In his research on the 1930s in the wake of the Wall Street crash, though, he pointed to the opposite problem: the Fed’s tight monetary policy, at a time when people wanted to save and not invest, was a prime cause of the Depression.

The test of whether central banks have kept market interest rates in line with the natural rate is whether they have kept inflation at its target. In the US, the average inflation rate from 2000-2019 was 1.8 per cent, and fell to 1.6 per cent in the period after 2008 during the long struggle to recover from the recession. In the eurozone, it was 1.7 per cent falling to 1.3 per cent. In other words, inflation was consistently below the figure of 2 per cent by which price stability is widely defined.

That implies central banks have kept interest rates close to but slightly above their natural rate over the past two decades. Monetary policy was too tight, it had a deflationary bias. That is not surprising given the well-known difficulties central banks have had in stimulating economies once short-term interest rates hit zero.

Now imagine if central banks set out to reward German savers, bankrupt zombie companies or hold asset prices down. To do so, they would have to raise interest rates further above the natural rate, and that would cause deflation. When central bankers are legally bound by their mandate of price stability, the option, simply, is not open to them.

There is something of a test case for what happens when you do hold interest rates above their natural rate: Japan. In the late 1990s and 2000s, Japan ran a tight monetary policy. The result was two lost decades, with stagnant growth, underemployment, falling asset prices and average inflation of 0.2 per cent from 2000-2019.

Anybody arguing that the Fed and European Central Bank should adopt higher interest rates to tackle zombie companies, or cool equity markets, should state clearly that a few lost decades is a price they are willing to pay.

The real problem is that the natural rate of interest is in decline, for reasons that are still uncertain but range from demographics to lower productivity growth. Rather than rage against central banks, people should direct their ire — and their efforts to find a solution — in that direction.

From a COVID-19 Recession to COVID-19 Depression?

By: George Friedman


It’s been roughly five months since COVID-19 lockdown measures were first put in place. That means that come September, we will have gone two quarters like this with no end in sight.

Masks and social distancing contained the spread of the virus somewhat but could never eliminate it.

Yet that is the only containment strategy we had. The only real solution is a vaccine. Many have already claimed that a vaccine is coming soon, but even if comes to market in September, producing, distributing and administering it to billions of people will be a time-consuming and logistically fraught process. Obviously, the number of people vulnerable will decline over time, but it is not clear that social distancing or quarantining will be suspended simply because a vaccine will be available.

They will likely continue.

I have argued that unless a solution is found by September, the probability that the recession could turn into a depression would mount. A recession is a normal part of the economy, a primarily financial event that imposes disciplines on an overheated economy. A depression, from a geopolitical standpoint, involves the physical destruction of the economy, something that lays waste to businesses, dislocates labor and vaporizes capital. A recession is the economy cycling. A depression is an economy breaking.

I chose September because two quarters of intense economic contraction is instructive. Economists’ definition of a recession is two successive quarters of negative growth (also known in English as decline). This is generally enough time to understand how resilient an economy is. Uncoincidentally, it is also the point at which economies begin to recover in normal cycles. Under normal circumstances, basic economic structures remain intact during recessions so financial stimulus measures can restart the system.

There’s no evidence that the economies of the United States and Europe – the center of gravity of the global economy – are recovering. Last week, the EU reported that its economy contracted by 8.3 percent, the largest contraction since it started keeping records. In the U.S., some 20 million jobs were lost in April, and there has been no dramatic reversal in unemployment. Brick and mortar retail stores across the nation are shuttering. Many argue that COVID-19 merely speeded up the inevitable.

But even if that is true – and it may be – simultaneous collapses of an economic sector should not be regarded lightly. It’s unclear just how many businesses have gone under because of delays in reporting, backlogs in the legal system, and so on. But it seems to me that retail collapse was merely the most visible sign of a tidal wave of bankruptcies not yet measured by the system, locking the unemployed into a difficult position.

So far, a depression has been delayed by massive government intervention. The United States spent trillions of dollars to stabilize the economy and avoid economic destruction. It did not reverse the collapse of March and April, but it blunted the damage by infusing capital into businesses, provided that they retain their employees. The problem was that demand fell not just for a lack of money but because of a lack of will to go purchase goods.

There was a contraction of effective demand, not only from lack of money but also because trips to the store became heroic undertakings. The stimulus could not continue. Lack of demand led to business failures, which led to unemployment. This is what the beginning of a depression looks like.

The European stimulus, which came later, was more complex but the basic economic principle is the same: At a certain point, the value of the currency declines as supply surges, making cash injections unsustainable. Weimar Germany is a good example – think about that iconic, if possibly staged, picture in the 1920s of a man with a wheelbarrow full of deutsche marks going to buy a loaf of bread.

The danger of the collapse of a currency vastly compounds economic failure. It cuts off investment at a time when it alone could stabilize the system.

The past two quarters have been a time of coming to terms with the medical reality and, more important, with life lived under the only medical mitigation there was: masks and isolation. There was a sense developing since June that this was simply what we would live with, and for many, it was a tolerable solution. What I think was less understood was that the economy had not reached a stable if unpleasant plateau, but was being held in place by inertia and government stimulus, and that the economy was fragmenting under the surface, past the point where government stimulus and patience would keep it together. In other words, the relative safety of the plateau afforded by the medical solution was being undermined and eaten away by unemployment and bankruptcies.

As we move into September, business failures will begin to mount, unemployment will soar, and underemployment may be even worse. It will be a time of instability and unpredictability. In past depressions, there was vast social unrest reflected in political fragmentation between those who suffered the most and those who didn’t. Sometimes the system can balance it, but usually it cannot, giving birth to a powerful political movement championing the dispossessed. In Europe, it was usually right-wing parties crushing the left. We are far from that point, but the coming U.S. election will be a harbinger of what might come.

Depression scares me. It creates not only vast human suffering but also political monstrosities. It is clear at this point that the current medical solution will remain in place until there is a vaccine. It is also clear that even with the best of luck a vaccine will not be fully produced, distributed and injected to a degree necessary or in time for the current solution to be improved.

By that time, the economy will be in a very dangerous condition, if it is still salvageable. But the sooner a vaccine is found the less the danger will be. It should be remembered that after the European and American depressions of the 1920s and 1930s, there was not only political extremism but also war. History does not repeat itself, which is a great comfort – save that, as Mark Twain pointed out, it does rhyme.

HSBC Has More Problems Than Covid-19

Linking East and West has been a good business for the Asia-focused bank, but it is getting harder to balance political priorities in its main markets

By Rochelle Toplensky




HSBC HSBC -4.72% was established to connect the West and the East. It has been a sound strategy for most of the past 155 years, but currently has the bank caught in a geopolitical web over which it has little control.

On Monday, the bank announced disappointing second-quarter results as a result of Covid-19-related provisions. Yet the fallout from the health crisis seems manageable compared with the political uncertainties HSBC faces in each of its main markets: China’s creeping control over Hong Kong, escalating tensions between Washington and Beijing, and the economic impact of Britain’s exit from the European Union.

It was a brutal quarter. Profits were helped by higher fixed-income trading revenue, but hit hard by lower interest rates and big provisions for loan losses—$3.8 billion in the quarter, with a warning that they could rise to $13 billion for the full year. The shares fell nearly 4% in morning trading.

Recently appointed Chief Executive Noel Quinn continues to restructure HSBC’s operations, pivoting toward Asia. In February, he announced an overhaul that included 35,000 job cuts and a promise to shift $100 billion in risk-weighted assets to Asia. Cost reductions are behind schedule, mostly because redundancies were paused in the second quarter. Mr. Quinn is considering how to move faster or do more, particularly in Europe and the U.S.

The bank has no choice but to focus on its Asian operation. It generates most of its profits, has the juiciest growth prospects and is very cost-efficient. In the first half, HSBC’s ratio of cost to income was 44% in Asia, compared to 101% in Europe and 73% in North America.



The company’s U.S. foothold is important as it provides dollar-clearing services to global clients, but U.S. retail operations are another matter. The lender continued its U.S. reorganization despite Covid-19, closing half of its branches in the country, primarily in the northeast. HSBC kept its west coast locations, which focus on wealthy clients often with strong connections to Asia.

HSBC’s shares have usually traded at a premium to European peers because of that eastern connection. The gap has shrunk recently as tensions have grown between Beijing, Hong Kong and Washington. The lender’s decision not to pay dividends this year, under extreme pressure from its Bank of England regulator, also upset retail investors in Hong Kong.

Financially, there are more tough times ahead, particularly as Covid-19 reemerges around the world. However, HSBC has a very solid 15% core Tier 1 capital ratio and, as a blue-chip player, traditionally attracts deposits in downturns. Although dividends aren’t expected until 2021 at the earliest, investors are unlikely to have to stump up additional capital.

The geopolitical questions are harder for HSBC to answer. The bank has traditionally been extremely discrete in its political dealings, but was recently forced to side publicly with China when the tensions over Hong Kong flared up. As Beijing becomes more assertive, and Washington finds unity in a hawkish stance on China, this seems likely to happen more.

European fund managers, who are paying more attention to “social” factors in their investment criteria than they used to, might start to see greater risk in HSBC. The geopolitical discount now battling with the stock’s traditional Asian growth premium could prove hard to shake.

How to Close America’s COVID-19 Testing Déficit

The US is facing a major health and economic catastrophe for one simple reason: its existing COVID-19 testing infrastructure has broken down. There is still time to build a new system that enables policymakers and the public to understand where outbreaks are occurring and where they are likely to occur next.

Simon Johnson

johnson130_ John ParaskevasNewsday RM vis Getty Images_covid testing


WASHINGTON, DC – To track the presence of SARS-CoV-2, the virus that causes COVID-19, the United States is relying heavily on polymerase chain reaction (PCR) live virus testing at massive scale. In the most common version of this approach, samples – nasal swabs or saliva – are sent to relatively large labs, with the goal of returning results within 24-48 hours.

Unfortunately, while some priority tests receive speedy turnaround, it now typically takes 7-22 days to get results across most of the country. For a fast-moving virus like SARS-CoV-2, which can progress from infection to final outcome (death or recovery) in as little as eight days, long delays mean that PCR virus testing is a waste of time and money. By the time you know the result, it is too late to do anything different.

From Latin America’s lost decade in the 1980s to the more recent Greek crisis, there are plenty of painful reminders of what happens when countries cannot service their debts. A global debt crisis today would likely push millions of people into unemployment and fuel instability and violence around the world.

For “surveillance testing,” an essential part of preventing outbreaks, two highly unequal worlds are emerging. Big companies and universities will pay top dollar to test all their people at high frequency (once or twice a week, with quick results), while everyone else will effectively not be tested (because results obtained after more than three days are of negligible value). This arrangement is not only hugely unfair (in ways that will become increasingly visible); it will also contribute to repeated resurgence of the disease in the coming months.

Quickly detecting COVID outbreaks is currently the main available tool for keeping people safe and retaining any reasonable level of economic activity (and jobs). More than 750,000 people, on average, are currently tested for live virus every day in the US. But this is far from enough in a country of around 330 million people, with a workforce of around 165 million, roughly 57 million schoolchildren, and another 20 million trying to attend some form of college.

With infection rates surging in some western and southern states (and parts of the Midwest now at risk), regional labs reach capacity and an increasing amount of testing must be done elsewhere. In New York City, where transmission currently is relatively low, the authorities want to test 50,000 people every day, but can manage only 20,000-30,000, with one-quarter of them taking more than six days.

Proposals to scale up live virus testing to 100 million tests per week (or even per day) will have to overcome the capacity constraints – reflected in jammed testing stations and shortages of key supplies. Because a clinical diagnostic industry (usually running individual tests ordered by doctors) is being asked to switch to mass production, an XPrize competition to promote decentralized technology (such as rapid at home tests), backed by serious capital, will help, but will take time.

What we really need now for outbreak detection – and therefore for a speedy public-health response to emerging hotspots – is a system that is scalable and cheap, based on proven technology, a robust supply chain, and sample collection that can be carried out without the involvement of medical personnel.

This system also needs to generate data that can be used to maintain accurate and detailed situational awareness for local officials and anyone who is thinking about taking a bus, meeting people indoors, or sending their children to school. All of this can now be built on the basis of dried blood spot (DBS) serology, a highly accurate way to check for antibodies.

An antibody test indicates if you have been infected with COVID-19. But antibodies are not detectable until 5-10 days after infection – 2-3 days slower than the live virus. Of course, once the delays for virus testing hit seven days or more, antibody tests are unambiguously faster and more accurate.

The test kits could not be simpler: a sterile lancet, a piece of filter paper, an adhesive bandage, and an envelope to send the blood spot to the lab, which runs it through an overnight process and can return results immediately (Galit Alter at the Ragon Institute has developed just such a process). The cost per DBS serology test is a fraction of what PCR labs currently charge.

A monthly DBS test would not only help people understand if they have been infected, but would also generate a vast amount of information regarding the progress of the virus across the US population. Armed with that information, live virus testing and other resources (local quarantines, good face masks, etc.) could be allocated more efficiently to quell any major outbreak.

Michael Mina at Harvard has described how this should work at the global level, and Caroline Buckee, also at Harvard, Jessica Metcalf at Princeton, and their colleagues have also addressed key issues.

COVID-19 testing is a major public good – like clean water or anti-malaria measures – with enormous spillover effects, meaning the benefits for society from reducing infectious disease are immense and not necessarily reflected in what people are willing or able to pay. The private market cannot deliver an efficient solution on its own: some people will get a lot of testing and many more will get none, but everyone will face the uncertainty and anxiety created by the prospect of random death. To overcome this problem requires a substantial commitment of public resources to a better testing system.

For immediate results, we have rapid antigen tests, which are arriving in increasing numbers from Quidel and Becton, Dickinson and Company, and some PCR machines can give results within 30-45 minutes. But there is a limited supply of both tests, which should be reserved for nursing home staff, emergency personnel, hospital workers, and medically necessary situations. Moreover, rapid tests are likely to generate more false negative results, so they need to be used wisely.

The US is facing a major health and economic catastrophe for one simple reason: its existing COVID-19 testing infrastructure has broken down. To get ahead of the virus, policymakers and the public need to understand where outbreaks are occurring and where they are likely to occur next. A better testing system, based on DBS serology, is available. Will it be used in time?


Simon Johnson, a former chief economist at the International Monetary Fund, is a professor at MIT's Sloan School of Management and a co-chair of the COVID-19 Policy Alliance. He is the co-author, with Jonathan Gruber, of Jump-Starting America: How Breakthrough Science Can Revive Economic Growth and the American Dream.

A lost asset

Emmanuel Farhi has died at the age of 41

The economist was one of the brightest minds of his generation




Emmanuel farhi showed a lot of promise in a lot of fields. At 16 he won a national physics competition in France. In the test to enter its most prestigious engineering school, he received the highest mark. After considering a career in maths, he settled on economics, where he flourished.

“He was one of the greatest economic minds of his generation,” says Xavier Gabaix, a colleague at Harvard University. But on July 23rd that career was cut short when Mr Farhi died unexpectedly at the age of 41.

His research interests were unusually broad, covering competition, international macroeconomics, tax and productivity. The common thread was a motivation to help policymakers understand the world. With Mr Gabaix, Mr Farhi considered how to design taxes when people are not as rational as economists typically assume. Carbon taxes are thought to be a way of forcing consumers to bear the environmental costs of their choices.

But if future fuel consumption is not on people’s minds when they shop for cars, such a tax may not work, and rules that limit emissions would be better. In research with David Baqaee of the University of California, Los Angeles, he studied the sources of productivity growth, and showed that ignoring firm-level differences could obscure the overall picture.

Mr Farhi’s most-cited work was on safe assets, written in 2008 with Ricardo Caballero of the Massachusetts Institute of Technology and Pierre-Olivier Gourinchas of the University of California, Berkeley. They argued that the global demand for safe assets had outpaced supply over recent decades.

America’s economic and political might made it well-placed to service this savings glut. As a result, its current-account deficit had bulged, and its assets accounted for a bigger slice of global portfolios.

That paper spawned more research on how the world was stuck in a “safety trap”. Demand for havens had led to an appetite for pseudo-safe assets, such as packaged subprime loans. But these were soon revealed to be far from safe. And, after the debt crisis of 2010-12, investors realised that sovereign bonds in the euro zone were wobbly. The result was a severe global shortage of safe assets.

Interest rates fell but, having fallen to around zero, could not decline further. The result was that interest rates for households and firms were, in effect, too high—and, in turn, their consumption and investment too low.

Mr Farhi saw America’s role as the world’s banker as unsustainable. If it produced too few safe assets then, with interest rates unable to adjust fully, global aggregate demand would stay depressed. But if it tried to keep up with investors’ demand for safety, its ability to repay its debts might one day be called into question. Speaking to the Richmond Federal Reserve in 2019, he noted America’s shrinking share of the global economy and worried that its role was becoming too much to bear.

One solution would be for other issuers of safe assets, such as the European Union or China, to emerge—though in a paper with Matteo Maggiori of Harvard, Mr Farhi warned that the transition could be messy. For now, investors doubting the safety of American government bonds had few other places to park their cash.

But as alternatives became available, Treasuries would become much more vulnerable to self-fulfilling crises. The dominance of the dollar would be challenged, said Mr Farhi in 2019, though “you have to take the long view here and think about the next decades, not the next five years”.

The tragedy is that he did not live long enough to test the prediction.