Is the Federal Reserve Creating the Next "Great Recession"? by Robert W. Merry
The summer issue of The International Economy magazine contains a feature that deserves some attention, even from those who don’t fully understand all the intricacies of economics. It is a cover package called “The Great Bubble Debate,” and it explores the doctrinal conflict that has emerged between Federal Reserve chair Janet Yellen and the Bank for International Settlements, which is an organization of the world’s central banks that “fosters international monetary and financial cooperation”and provides banking services to central banks.
The settlement bank’s recently released annual report argues that the Fed’s current monetary stimulus policies, coupled by similar policies at other central banks, could create another major financial bubble that could prove disastrous when it bursts. The report states that persistently low interest rates, like those maintained by the Fed since the Great Recession, “can also have the perverse effect of incentivizing borrowers to take on even more debt, making an eventual rise in rates even more costly if debt continues to grow….[L]ow interest rates do not solve the problem of high debt.”
Yellen fired back with what Bernard Connolly of Connolly Insight called “a direct attack” on the BIS, referring to the settlements bank obliquely—and “somewhat dismissively,” in Connolly’s view—as “certain quarters.” Yellen argued that the extraordinary monetary measures taken by the major central banks since the 2008 financial crisis reflect necessary and prudent policy choices as the industrial nations struggle to shed the lingering effects of that crisis.
The magazine package consisted of Connolly’s article plus thumbnail analyses from twenty-three experts from around the world, and it reflected a powerful and intensifying intellectual clash. As the magazine puts it in introducing its package, “For the first time since the monetarist vs. Keynesian debate of the 1970s, the economic policy world is in stark intellectual disagreement.”
It isn’t the purpose of this report to sort out that stark intellectual disagreement, but rather to highlight it and signal its significance in the sometimes-shrouded policy world. Embedded in the debate may lie keys to understanding just how precarious the international economy really is.
As Connolly describes the BIS argument, it is essentially that the present extremely low interest rates pose two dangers. First, they serve to bring spending forward from the future “and thus create a potential future ‘hole’ in demand which will produce a need for even lower rates, and so on.” Second, they can undermine financial stability by encouraging savers, investors and financial intermediaries to engage in "reach for yield" behavior—taking on ever more risky investments. Connolly adds, “And although the BIS does not say so explicitly, its view implies that sub-‘normal’ rates must involve a Ponzi game and eventually lead to another financial crisis.”
Yellen countered that various factors—slower productivity growth, “headwinds from the financial crisis” and demographic trends—require what are in essence historically low “so-called equilibrium real interest rates.” Former Treasury secretary Larry Summers has bolstered her position by arguing that the global economy’s fundamental foundation may be so weak that financial bubbles are required on an ongoing basis to sustain global growth.