This year’s Jackson Hole convocation of central bankers offered a look at how the same basic tool can be transformed and used in different ways to combat different problems.
Both Mario Draghi, president of the European Central Bank, and Bank of Japan Governor Haruhiko Kuroda both talked about the possibility of quantitative easing to solve substantially different problems. Janet Yellen, chairwoman of the Federal Reserve, said that for now the Fed would hold back from boosting interest rates and tightening up on the U.S.’s use of QE to combat a third issue. All three problems, however, had a substantial labor market element that emphasized the difficulty of possible solutions.
In her Jackson Hole speech, Yellen said that the failure of the labor market to fully recover from the recession and “the possibility that the severe recession caused persistent changes in the labor market's functioning” mean that it’s too soon to take an aggressive approach to ending QE in the U.S. While the Fed is expected to wind down bond buying in October, Yellen made it clear that interest rate hikes weren’t on the agenda quite yet.
Kuroda is fighting a different problem: deflation accompanied by a relatively low unemployment rate. And the ECB faces a third: a high average unemployment rate of 11.5%. The ECB’s difficulty, though, is that unemployment is very unevenly spread throughout Europe, with mostly southern European countries such as Spain and Italy suffering far worse than Germany and the Nordic countries.
Yet both Japan and Europe are considering QE in different forms.
Kuroda talked about the need for Japan to combat deflation by stimulating inflation, and to increase wages to counter a stagnant economy. He also emphasized the need for the country’s employment situation to return from a greater reliance on temporary workers back to a permanent workforce populated by employees who can actually look forward to negotiations for higher pay.
One way Kuroda hopes to encourage spending is to encourage investing by making it more attractive for companies to change back into investors instead of cash hoarders. This is something they became thanks in substantial part to wage cuts that drove up profits during the long period of deflation.
In Kuroda’s words, “firms, which used to be net investors, turned into net savers and have stayed in that position.” This is unhealthy, he said, because of the “paradox of thrift [italics Kuroda’s]. If firms use profits obtained through wage cuts to build up internal funds rather than for investment, aggregate demand in the economy will shrink.”
Kuroda said a lot more about how the economy needed to encourage spending, both on the part of companies who have held cash in reserve and on the part of consumers who still hesitate to spend, in anticipation of further price drops. He suggested that if increases in both prices and wages can be encouraged by the government and expectations stabilized around an inflation rate of two percent, “Firms and households can then base their economic decisions firmly on the expectation that prices will rise at [that] rate” and thus feed the economy through a resumption of spending.
As an indication that the government is willing to step in to make sure that pay rates start to increase again, Kuroda said in his Jackson Hole speech, “A visible hand is necessary for wages to rise.”
To that end, QE may be deployed in the form of interest rates even lower than they are at present, to encourage investors to take what John Blank, chief equity strategist for Zacks, called “the ultimate carry trade: you borrow in yen and put [the money] to work...”
Blank said Japan’s move to rebuy its bonds means that investors who sell them back and are paid in yen “have to buy something with [the] yen [they’re paid for the bonds], so [they] have to buy in Japan. Japan wants you to spend and consume, and drive up prices [there].”
Draghi at the ECB, on the other hand, is fighting a different battle. He’s trying to convince European countries to act in concert to combat slowing inflation—hovering in the euro area at 0.3%, considerably under the ECB’s goal of 2%—as the possibility looms that such low inflation will do something akin to what it has done in Japan: cause investors, consumers and businesses to hoard cash and stop spending as they anticipate prices falling yet lower.
Draghi pointed out in his own speech that euro zone unemployment has soared twice—the first time in response to the global financial crisis but the second in relation to the “euro area-shock emanating from the sovereign debt crisis, which resulted in a six-quarter recession for the euro area economy.”
He continued, “Unlike the post-Lehman shock, however, which affected all euro area economies, virtually all of the job losses observed in this second period were concentrated in countries that were adversely affected by government bond market tensions.”
Saying that the “credit gap,” the difference between actual and normal volumes of credit within stressed euro zone countries, “suggest[s] that that credit supply conditions are exerting a significant drag on economic activity,” Draghi also said that estimates from the European Commission, the OECD and the IMF suggest an increase in structural unemployment across the eurozone.
The current rate of 11.5% averages a rate of close to 5% in Germany with a 25% rate in Spain. However, the way countries are experiencing and dealing with unemployment varies greatly, with “the relationship between labor market institutions and the impact of shocks on employment.” Draghi also said that the risks of doing too little to address the unemployment situation are higher than the risks of doing too much—permitting inflation and upward wage pressure.
So what does that mean? Draghi said that in September the ECB would launch its “first Targeted Long-Term Refinancing Operation” amid “fast moving” preparations to engage in “outright purchases in asset-backed security (ABS) markets” intended to “meaningfully contribute to diversifying the channels for us to generate liquidity.”
But he is also pushing for nations to cooperate on broader policy measures that several, thus far, have been reluctant to adopt: lower taxes, more spending and more cooperation among nations to achieve goals that the euro area’s current status as an informal political union lacks: the “permanent mechanisms to share risk, namely through fiscal transfers.”
It is likely that Germany will continue to resist, as it has so far, engaging in anything that will boost inflation and upset its own economic applecart with regard to either wages or unemployment. In addition, countries such as France and Italy may not heed his call for structural reforms that could affect their own labor markets negatively, since they are already feeling the effects of a lack of economic growth.
However, it remains to be seen whether the size and longstanding nature of the unemployment crisis across Europe could mean that change is at last in the wind.