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…”