“Banks should be much more worried about the disruption by big tech than by negative interest rates” – interview with Kenneth Rogoff

“The biggest immediate risks to the global economy right now are an even sharper than expected collapse in the long-term arc of China’s growth trajectory, and the huge uncertainty surrounding what comes next in the trade war.” Kenneth Rogoff, professor at Harvard University, former Chief Economist at the International Monetary Fund has been invited to Budapest by the MNB department of the Corvinus University of Budapest. In his interview given to Economania blog, he lists the main risks to the global economy and the predominant role of the US dollar. He also explains, how an efficient monetary policy can be conducted well below the zero lower bound.

Lehmann Kristóf (LK): Analysts and economists nowadays discuss the possibility of a coming global recession. What is your view on the outlook of the global and the U.S. economy?

Kenneth Rogoff (KR): Historically, recessions tend to happen once every seven or eight years, and after such a long expansion, of course it is distinct possibility. Still I would put the odds of either a global or a US recession before the end of 2020 clearly under 50%.  That said, the global economy is wobbling, and for several reasons.  First and foremost, the four decade arc of China’s miracle growth period is coming to an end.  The rise of China has surely been the most important development in the global economy over this period, and is a major factor in many if not most of the major developments.  Going forward however, it is going to be extremely hard for China to maintain a six percent growth rate, but much less the 8-10 percent growth rates it had been clocking year after year until recently.  There are several factors.  First and foremost, the labor force is no longer growing, a large part of urbanization has already taken place, and the one child policy (even though now relaxed to a two-child policy) has profound effects on demographics going forward.  Second, China’s momentum from technology catch-up has surely slowed now that it has approached the frontier in so many areas.  Third, China’s go-to stimulus policy has been to expand credit to fuel infrastructure development, about 70% of this credit goes into residential real estate.  Now, however, after so many rounds of stimulus, debt burdens are high while China already has roughly the same square meters per capita of housing that Germany and France have, even though it is a much poorer country.  Over the next decade, China will do well to maintain a 3-4% growth rate (which would still be phenomenal by advanced-country standards, given zero to negative labor force growth.)

Into this difficult situation, the trade war is having a profound impact on confidence in China, and is difficult for the authorities to counter it, given that stimulus by credit growth is getting increasingly risky.  Indeed, the classic emerging market financial crisis often happens when fast growth begins to normalize, and the authorities try to use debt to keep things going at an unsustainable pace, in part because they fear the public has come to think of ultra-fast growth as normal.

The slowing arc of China’s growth, exacerbated by the trade war, has hit countries hard that depend on China.  This is probably at least half the reason Germany is experiencing what is already a mild recession, that could easily get worse.

That said, the United States is still growing solidly, although uncertainty surrounding the trade war has cast a pall over capital spending, and the more recent consumption numbers are also somewhat worrying.  Still, for the moment the US has much more momentum than Europe.  It is actually possible that we could have the first global recession in which the United States manages to keep positive growth. (One of my efforts when I was chief economist and director of research at the IMF from 2001-2003 was to oversee a project aimed at defining a global recession).

So, to summarize, the biggest immediate risks to the global economy right now are an even-sharper than expected collapse in the long-term arc of China’s growth trajectory, and the huge uncertainty surrounding what comes next in the trade war.

These are not tail risks, but ongoing events where the only question is how big the shock will end up being.

The biggest tail risk in the global economy would be something that caused global real interest rates to start trending up after several decades of trending down.  Virtually any measure of global debt (corporate, emerging markets, advanced economies, etc.) is at record highs.  There is no particular problem financing at the moment, given the phenomenally low level of real interest rates.  But the truth is that we don’t really fully understand why they have fallen so much.  Although many emphasize demographics and low growth, there is little question that the big drop happened after the financial crisis, and perhaps has something to do with elevated tail risk (My 2015 Journal of International Economics paper with Vincent and Carmen Reinhart demonstrates this point using a model of Robert Barro).  If, for some reason, the secular decline in global real interest rates were to start going into reverse, even say rising 1.5 percent over two years, there would certainly be large pockets of distress, especially given that as advanced economy interest rates rise, interest rates to high risk borrowers tend to rise far more than one for one.  It is not hard to imagine Italy having a problem, many emerging markets, etc.

Another tail risk is the dollar and relates to global governance.  We live in an era of dollar dominance unlike anything we have witnessed until now, even more so than during the Bretton Woods period of the 1950s and 1960s.  The euro, by comparison, is basically a regional currency.  (There are a slew of papers on this issue of late, including my 2019 Quarterly Journal of Economics paper with Ilzetski and Reinhart.)  The question is how stable this equilibrium will prove if the US veers off on an extremely populist economic policy, even more so than we have now.  Two and three trillion dollar deficits are a distinct possibility in the years after the 2020 election, whichever side wins.  Some economists such as Olivier Blanchard have suggested this much larger deficits are probably nothing to worry about.  He might be right.  But if he is not, the stress on US inflation and stability could lead to a quite destabilizing global currency system. Again, this is only a tail risk, but as we watch the drama in Washington unfold these days, it has to be mentioned. I have long argued that emerging markets that hold large reserves might want to diversify away from the US dollar, even a bit into gold.

LK: How likely is it that the Fed will have to cut rates to negative territory?

KR: Given the continuing decline in global real interest rates (both long-term and short-term), we are likely to see negative rate policy eventually come to all the major economies, certainly the United States.  That said, for negative rate policy to be fully effective, countries need to take a number of steps to clear regulatory, legal, and institutional obstacles. My 2016 book “The Curse of Cash” (which perhaps would have been more accurately titled “The past, present and future of currency and monetary policy”), gives an extended discussion of what needs to be done, nothing is particularly difficult once a country is determined to move ahead.   My book recommends providing government subsidized zero interest rate accounts for everyone up to perhaps a few thousand dollars; this would not be difficult and it would not be expensive since the central object of negative interest rate policy is to stabilize growth and inflation (as with normal monetary policy) and not to generate revenue for the government.  In order to have deep negative rates, it is also imperative to discourage large players such as financial firms, pension funds and insurance companies from hoarding tens of billions of dollars in cash (small and medium size players do not matter so much).  My book details many ways to do this.  Given the ever declining use of cash in legal, tax-compliant activities, there are really a large number of ways to do this.  Simply getting rid of large bills would help for sure, but most schemes require some kind of tax on large redeposits into the banking system into to deal with hoarding (cash pays zero interest and despite significant storage and insurance costs, bulk cash storage might prove attractive at steeply negative interest rates without some such tax scheme.) Again, my 2016 book lays out a few plausible strategies.  I might mention that the banking lobby hates negatives rates under current regulatory policy because they feel banks will treated unfairly.  I believe, however, that once countries fulfill the necessary preconditions, banks will not lose at all.  (Banks should be much more worried about the disruption by big tech than by negative interest rates.)

LK: The ECB is also among the central banks whose monetary policy seems soon to be constrained by the effective lower bound (O/N depo rate currently at -50 bps). Do you think that your idea played a role in the recent ECB decision to stop issuing new €500 banknotes?

KR: I certainly did not have any direct role, I cannot take any credit, although certainly my work is well known in central banks and treasuries. (Larry Summers and Peter Sands who started writing about this in 2016 certainly knew about my 1998 paper on the topic, they may have had more direct influence.)  I do know that there are many countries that have considered issuing larger notes (to makeup for decades of inflation), but have taken into consideration my arguments.

LK: According to Fed, ECB and Bank of Canada officials, these central banks are revising their current strategies. Official communications suggest that symmetry in the inflation target (meaning that after undershooting the inflation target overshooting is needed) might be an important idea in these revisions. How do you see the symmetry of the goal and the future of inflation targeting?

KR: Of course, symmetry is a good idea, I believe that too many central banks have been painted into a corner by what I term in my book “inflation targeting evangelism.” Even in the United States, the public does not see the inflation target as symmetric.  It is a big problem.  My 1985 Quarterly Journal of Economics paper (which introduced the first theoretical model of an independent central bank as well as how it would operate with inflation targeting), strongly argues for a symmetric target.

LK: Many economists argue that in the future the role of fiscal policy in stabilizing the economy should and will increase. Do you share this view?

KR: Well, it has to be tried.  But fiscal policy will never serve as long-term substitute for monetary policy.  As Milton Friedman argued long ago, fiscal policy is simply too hard to fine turn.  In countries with deep political divisions (like the US), it is very hard to see how to manage a stable effective countercyclical fiscal policy.  When the Democrats are in office, they will push to make government spending much higher.  When the Republicans are in power, they will push for tax cuts so that in the long run, government spending has to be lower.  Almost any modern model of fiscal policy emphasizes that its effectiveness depends not only on the current but on future policy. Making future monetary policy credible is hard enough, making future fiscal policy credible in a deeply divided political system is well neigh impossible.  Another issue is that the typical advanced economy recession lasts only 9 months to a year. The history of fiscal stimulus is that it often comes into play after the recession is over.  Indeed, that is exactly happened in the US the past few years, where massive fiscal stimulus was put into place after the economy has already substantially recovered.   In any event, given that most countries are not ready to experiment with deeply negative interest rates (that could take another five to ten years), they will all try fiscal policy in a big way in the next recession, for better or for worse.

Lehmann Kristóf

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