Are low interest rates doing more harm than good?

Mark Carney was oddly framed by TV cameras when he made his hasty post-Brexit address the morning after the United Kingdom voted to leave the European Union. Standing behind a lectern, but in front of an open doorway, the governor of the Bank of England appeared as though trapped inside a box. It was fitting for a man who’s now expected to fix the U.K.’s looming economic crisis using, mainly, a single, indiscriminate weapon—interest rate policy—that’s been mostly emptied of ammunition. Nevertheless, as the British pound plunged to a 31-year low and stock markets around the world temporarily swooned, Carney declared the central bank was “well prepared” for the uncertainty ahead. He fleshed out the central bank’s plans a week later when he relaxed capital requirements for banks and all but promised to cut rates to 0.25 per cent, from 0.5 per cent now, at the Bank’s next monetary policy committee meeting. “The economic outlook has deteriorated,” he said, “and some monetary policy easing will likely be required over the summer.” That the Bank ultimately shocked markets on July 14 by holding rates steady, at least for the time being, suggests a growing reluctance to use what little monetary firepower it has left.

Over the past eight years, central bankers dutifully played the role of stern-faced economic saviours—always at the ready with a rate cut or two—as the world stumbled from one crisis to the next. But despite making the cost of borrowing money nearly free for almost a decade, as well as injecting trillions of dollars worth of additional monetary stimulus into the global economy, the efforts have failed to deliver the intended result: robust, sustainable growth. In the U.S., for example, the Federal Reserve cut its target funds rate to 0.25 per cent in the wake of the 2008 crisis and, with the exception of last December’s quarter-point hike, has left it there ever since. It’s also pumped US$3.5 trillion into the economy through three rounds of quantitative easing, which amounts to printing money by purchasing bonds and other assets from financial institutions. And yet, annual U.S. real GDP growth never managed to crack 2.5 per cent, making it one of the slowest recoveries in history, according to the U.S. National Bureau of Economic Research. The European Central Bank, meanwhile, is in the midst of a quantitative easing program worth one trillion euros while the eurozone continues to flirt with recession. The same goes for Canada, which saw the Bank of Canada cut rates twice last year to offset the worst effects of the oil crash, yet has still seen its non-energy sector well underperform expectations. Meanwhile in China, the ruling Communist Party has mostly abandoned its pledge for badly needed economic reforms as it seeks to maintain GDP growth of at least 6.5 per cent, creating fears about a debt time bomb waiting to explode.

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With Brexit representing merely the latest shock, economists warn the planet is at risk of sliding into a low-growth trap in which companies retrench, wages are slashed and consumers spend less—all at a time when central bankers seem powerless to do anything about it. At the same time, the risks to the financial system are mounting as the myopic focus on monetary policy—including once heretical ideas like negative rates—pushes yield-starved investors into riskier assets like stocks and real estate, creating fears of destabilizing bubbles that could unleash brand new crises. Even the Bank of International Settlements, the so-called “central bank for central banks,” is concerned. “There is an urgent need to rebalance policy in order to shift to a more robust and sustainable expansion,” it wrote in an annual report released last week. “It is essential to relieve monetary policy, which has been overburdened for far too long.”

To that end the International Monetary Fund (IMF) and others have been calling on governments to orchestrate, essentially, a repeat of 2009 fiscal stimulus programs—this time with a focus on big infrastructure projects that pave the way for growth in decades to come—alongside structural reforms to promote global trade, research and education and an overhaul of inefficient tax policies. “This is where policy-makers should focus most of their attention,” says Domenico Lombardi, the director of the global economy program at Canada’s Centre for International Governance Innovation. “And yet, I see the debate is still focusing on monetary policy and what it can do.”

Which is to say, not much—at least not safely.

The U.K.’s decision to opt out of the world’s biggest single market, comprising some 500 million people, couldn’t have come at a worse time. Even before the referendum, there were ominous signs the global economy was at risk of another downturn. French shipping line CMA CGM earlier this spring pulled its “mega-ship” Benjamin Franklin—a ship as long as the Empire State building is tall—from its China-U.S. route because of a lack of sufficient cargo. Similarly, North American railroad executives say they’ve noticed a sudden reduction in container volumes, which are generally seen as a leading indicator of the health of the economy. Heavy equipment manufacturer Caterpillar reported a 12 per cent drop in its first-quarter sales of dozers, diggers, draglines and drills, among other things, the company’s 41st consecutive month of declining worldwide sales. And in Germany, yields on 10-year government bonds recently dipped into negative territory for the first time ever. Translation: investors are so nervous about the future they’re willing to pay the German government to guard their euros.

Such fears have only been heightened now that Brexit has put the future of the EU in doubt. In the near-term, U.K. businesses are expected to dramatically dial back investments, given the uncertainty around access to the EU market, which is the destination for 44 per cent of the U.K.’s exports. Goldman Sachs, the New York investment bank, is already predicting a mild recession in the U.K. next year that will have spillover effects in the rest of Europe and beyond. Likewise, China’s finance minister, Lou Jiwei, said the U.K. decision will “cast a shadow over the global economy.”

At some point, slow growth begets even slower growth. “After years of weak demand and unemployment, businesses have clearly underinvested,” Lombardi says, referring to spending on new products, manufacturing facilities and other corporate infrastructure. The cumulative effect is a global economy that now has less growth potential than it did just a decade ago. “This is the unpleasant truth that policy-makers face.”

But even as the world slides toward what the IMF dubs “stalling speed,” politicians continue to pressure central bankers to fix a problem that’s so far proved unfixable with conventional tools. So they’ve turned to the exotic. Already, Denmark, Sweden, Switzerland and Japan have crossed the monetary Rubicon by adopting negative interest rates. While the effect has mostly impacted financial institutions, which now effectively pay a fee to deposit cash with their central banks and are therefore more inclined to make loans, there have been instances of negative rates being passed on to consumers—at least on paper. “There has been some variable-rates loans that have had negative rates, but since fees are added on top no house owner has yet to be paid as far as I know,” says Michael Fenech-Andersen, a homeowner in the small Danish community of Sonderborg.

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Elsewhere in the world, the idea of “going negative” has gone from central banking taboo to just another unconventional policy tool, with Bank of Canada governor Stephen Poloz opening the door to negative rates last December and U.S. Fed chair Janet Yellen saying in May that she isn’t ruling them out. Miles Kimball, a professor of economics at the University of Michigan, says the experience of Denmark and others has demonstrated, at least thus far, that long-standing fears of negative interest rates are unfounded. That’s mostly because there’s a cost associated with storing and safeguarding cash (just like there’s a cost associated with providing a negative-rate mortgage) so people are unlikely to yank money out of their savings accounts, causing a run on the banks. Had the U.S. Fed known this, Kimball argues it might have been able to act more decisively in the wake of the 2008 financial crisis and avoided the long and painful recovery that followed. “If we had negative interest rates in 2009, we would have a robust recovery by 2010,” he says.

Of course, there’s a limit to how low central banks can go before withdrawing cash from an ATM and stuffing it under a mattress becomes an investment strategy. Which is why some, like former U.S. Fed chair Ben Bernanke, are floating an even more extreme tactic: “helicopter money.” Dubbed a “nuclear option,” the idea is to use the central bank’s printing press to fund tax cuts or other government stimulus programs. The term was coined by economist Milton Friedman who, in 1969, likened the idea to dropping money from a helicopter, an act of economic desperation if there ever was one.

The question then becomes what nasty side effects could these mostly untested policies unleash? Eight years of near-zero—and now subzero—interest rates have already forced investors to seek out returns in a wide assortment of alternative assets, creating massive bubbles in housing and smaller ones in artwork, fine wine, bitcoins and even U.S. farmland. In Denmark, the four-year-old experiment with negative interest rates, which mostly translated in near-zero rates on consumer-facing products like mortgages and savings accounts—has caused home prices to soar in big cities like Copenhagen and Aarhus and left Danish families among the most indebted in the world, owing more than three times their average take-home pay. Think of it as an extreme version of what’s happened in Canada, where house prices in Toronto and Vancouver have spiralled higher and families owe a record $1.65 on average for every dollar of disposable income they earn.

Low interest rates are also distorting stock markets. Public companies are borrowing heavily to buy back their own shares at the fastest pace since before the financial crisis, boosting share prices instead of investing in new factories or products, which may also explain why growth is slowing.

It’s enough to worry legendary corporate raider Carl Icahn, who warned recently, “I don’t think you can have zero interest rates for much longer without having these bubbles explode on you.”

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As the world’s central banks grasp at straws, the IMF and a growing number of economists have stepped up calls for governments—meaning taxpayers—to take a bigger role in reinflating the global economy. In February, the G20 called for a coordinated stimulus program to be implemented by the world’s major economies—or at least the ones that can afford it—that would see countries borrow to spend on infrastructure like subway lines and power-generating stations, assets that will provide a short-term economic boost while laying the foundation for longer-term growth. Doing so, the supporters of fiscal stimulus argue, would also ease the pressure on central banks to keep interest rates at emergency levels. That’s certainly been the argument put forward by Justin Trudeau’s government, which plans to take Canada deep into the red over the next several years, including a plan to spend $120 billion on infrastructure projects. Finance Minister Bill Morneau echoed concerns that central banks are tapped out. “I think there’s a sense that monetary policy can’t have as big an impact as it could have had a decade ago,” he said, “meaning we are going to have to think about fiscal measures that can make a difference.”

Yet while there are good reasons for spending on infrastructure—as anyone who has driven over one of Montreal’s crumbling overpasses can tell you—using government spending to grow the economy is easier said than done. Elected officials are easily swayed by short-term priorities that appeal to voters but may not be wise uses of borrowed money. The immediate impact of stimulus spending also tends to be muted in open economies like Canada’s, where money easily flows across borders—an uptick in GDP is likely to be offset by a corresponding rise in the value of the loonie, which, in turn, weighs down exports.

Plus, it’s not even clear whether the root causes of the world’s slow-growth conundrum have been accurately identified. In a recent presentation at the London School of Economics, Raghuram Rajan, the outgoing governor of the Reserve Bank of India and professor of finance at the University of Chicago’s Booth School of Business, argued it’s entirely possible the global economy is being dragged down by trends that aren’t easily remedied by stimulus of any sort. That includes everything from too many “zombie companies” kept alive by round after round of stimulus measures to the growing clout of the Internet, which, thanks to network effects, tends to favour the creation of monopoly firms that may have little incentive to operate efficiently. “It doesn’t seem like our global response targets these problems,” said Rajan. “We seem to think the problems are largely temporary and that sufficient stimulus will get the global economy back on track.”

In any event, it seems clear the biggest stumbling block to getting the global economy back on track will be politics, which, ironically, has become more fractious precisely because of the bleak outlook. The U.K. has voted to turn back the clock on trade and labour mobility, while the surprising rise of Republican presidential contender Donald Trump, who has campaigned on scrapping the North American Free Trade Agreement, suggests a sizable chunk of U.S. voters want the U.S. to do less business with the rest of the world, not more. In such a divisive environment, few governments are likely to risk pursuing ambitious, and no doubt controversial, reforms. Far easier to wait for the world’s central bankers to deliver a quick fix. No wonder Carney looks so hemmed in.

This story has been updated to reflect the Bank of England’s surprise July 14 decision to leave interest rates unchanged at 0.5 per cent.

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