Prudential CEO says QE "depressing growth"

Prudential's CEO, Tidjane Thiam, explains in a few brief comments why quantitative easing (QE) is a barrier to economic growth.

These comments should be familiar to regular readers as your humble blogger has been making this point for several years now.

As reported by the Telegraph,

“QE was a good short-term fix,” Mr Thiam said at a private breakfast last week. “In 2008, 2009 and 2010 it was the right answer. But now, it is different.  “We are just storing long term trouble by minimising short term pain.”

I would disagree with Mr. Thiam that QE was ever a good short-term fix as monetary policy is not a cure for a bank solvency led financial crisis.

The Prudential CEO ... said that the deepening market distortions created by quantitative easing had a negative effect on growth and damaged savers. 

Mr Thiam said that there was now a reliance on cheap money without a sensible exit plan. This, he warned, left the door open for inflation shocks that could throw the economic recovery off course. 

Mr. Thiam is absolutely right that QE damages savers and as a result has a negative effect on growth.  I refer to this effect as an economic headwind as savers cut back on current consumption to offset the loss in earnings on their savings.

Mr. Thiam's next point about the lack of a sensible exit plan is incredibly important.

Central bankers will say they have a sensible exit plan.  Unfortunately, these are the same central bankers who did not see the financial crisis coming and are frustrated that savers are not acting in the same way that the central bankers' models say they should act (with rates at 0%, they should be drawing down their savings rather than cutting back their current consumption).

“In the macro economy: savings equal investments. But QE is depressing savings and therefore depressing investment. This means, QE is depressing growth,” he said. 

While I agree with Mr. Thiam that QE is depressing growth, I don't agree with his causality.

QE and similar low interest rate monetary policies are depressing both return on savings and demand as savers offset the loss of income on their savings by cutting back on consumption.  By reducing consumer demand, QE is depressing the return on investment by companies.  Companies respond by reducing investments and this in turn further depresses growth.  Bottom line:  QE is depressing growth.

“It is a really strange economic strategy because everyone is looking for growth – but the monetary policy is completely anti-growth. There is no other exit to indebtedness than growth,” he said, referring to the UK’s £120bn or so deficit..... 

I agree with Mr. Thiam that it is a really strange to pursue anti-growth monetary policies like QE and similar low interest rate policies when the central bank is trying to stimulate growth.

I disagree with Mr. Thiam that the only way out of the indebtedness is growth.

There is a much quicker way.  Adopt the Swedish Model and have the banks recognize upfront the losses on the excess public and private debt in the financial system.

“I am very worried we are creating bubbles, everywhere. Interest rates will have to normalise. And it is not clear to me what the exit strategy is. I ask central bankers this all the time and I still have not heard a single sensible answer,” he said.... 

“QE creates a total distortion in the economy,” said Mr Thiam. “The risk free rate is possibly the single most important piece of economic information we have and we shouldn’t mess with it. That is a dangerous game, because, to manipulate the risk free rate is to introduce huge distortions.”

The role of central banks has always been to "distort" the risk free rate in an effort to smooth the business cycle (lower highs in economic expansion and lower lows during recessions).

What makes QE and similar low interest rate policies different this time is they have been shown to be ineffective at generating economic growth, but the central banks keep doubling down despite the lack of a sensible exit strategy and the huge distortions these policies are causing in the economy.