Escape from the Central Bank Trap by Daniel Lacalle
As reviewed by Dr. Caroline Gray, Senior Economics Editor at FocusEconomics
To ease or not to ease? When the European Central Bank took the decision to embark on a massive quantitative easing program in early 2015, it seemed to have little other option. With heavily indebted governments across Western Europe coming under fire from their citizens suffering the brutal effects of austerity measures, politicians were practically begging for some room for maneuver. And with interest rates already pretty much as low as they could go, the ECB’s only way of responding to the clamor was to start injecting liquidity into the economy, buying up government debt and thereby lowering bond yields and alleviating some of the pressure on governments.
Fast forward a couple of years, and the voices railing against quantitative easing are even stronger than those that initially clamored for it. While the theory behind quantitative easing suggests it should ultimately boost demand and investment and thereby the real economy, in reality the benefits in the Euro area seem to have been muted. At the same time, perverse situations generated by the ECB's bond-buying program have proliferated. The average yield of euro-denominated junk bonds, i.e. the riskiest, non-investment-grade corporate bonds, recently dropped below 3% to come remarkably close to the yields on U.S. Treasuries, which are much more liquid and considered the safest investment.
In his latest book Escape from the Central Bank Trap, Daniel Lacalle joins the anti-QE camp with a convincing tirade against so-called “unconventional” monetary policy, which he suggests has become far too common and conventional. He puts experiences of quantitative easing in the United States, Japan and Europe under the spotlight in order to denounce modern monetary theory as a short-term trap that fails to resolve structural imbalances, and argue instead in favor of supply-side policies.
In the European case, Lacalle argues, “the central bank did not function as a transmission mechanism to improve the real economy, but as a perpetuator and instigator of yet another asset bubble.” In other words, low-interest-rate risk has simply moved from house prices to bonds. ECB president Mario Draghi’s warnings to governments not to forget that QE is supposed to be a temporary measure, and that structural reforms remain as necessary as ever, have largely gone unheeded. And so the new bubble is being perpetuated.
Lacalle’s focus on structural reforms and supply-side measures puts him at risk of attracting the wrath of left-wing and anti-capitalist commentators and of being dismissed by them as a libertarian. But he anticipates and attempts to counter such criticism by arguing that quantitative easing has actually contributed to the rise in inequality that such commentators are concerned about. QE programs, he suggests, “disproportionately benefit those who have access to widespread credit and whose wealth is in financial assets,” while hitting ordinary citizens with small savings in cash, which becomes devalued.
“Even if the reader disagrees,” he says, “the question is simple. How do we get out of expansionary policies without another financial crisis that hurts, again, households and taxpayers the most?”
Lacalle does not mince his words in warning of the risks of prolonged QE. “If EU countries get used to ultralow rates,” he suggests, “the risk of multibillion nominal and real losses in bond portfolios and pension funds is enormous, because the tiniest tilt in inflation will make the house of cards collapse.” In the present scenario, “if interest rates raised a stunted one percent in the European Union, it would lead to massive budget cuts to maintain current deficits.”
The irony here, if we compare Lacalle’s words with European governments’ initial reasons for wanting QE, cannot go unnoticed. Since QE slashes borrowing costs, desperate governments had pinned their hopes on it reducing—at least marginally, and temporarily—the pressure for ever stricter austerity measures.
While most of the jury now seems to be out on quantitative easing, an alternative remains elusive. In addition to structural reforms to promote lower government spending and higher efficiency, Lacalle recommends tax cuts to let households and SMEs thrive. In this regard, he reminds us that in Europe, it was the Netherlands and the UK which emerged from recession earlier. They were the countries which reduced taxes rather than boosting government spending during the initial period of stimulus across the EU at the height of the financial crisis, prior to the shift to austerity.
Convincing citizens of all this and thereby making it politically viable is however entirely another matter, as Lacalle himself acknowledges. Tax cuts may be welcomed if the public perceives them as benefitting the ordinary citizen rather than just wealthy high earners, but on their own they cannot suffice. Meanwhile, citizens who have already suffered enough from austerity are understandably not about to change their tune and embrace the need for structural reforms, which often have an overwhelmingly harsh short-term impact before the longer-term benefits start to become apparent. The central bank trap is clearly anything but an easy one to get out of.
Author: Caroline Gray, PhD, Senior Economics Editor
Daniel Lacalle is a fund manager who holds a PhD in Economics and has a CIIA financial analyst title. He is author of “Life In The Financial Markets” and “The Energy World Is Flat” (Wiley) as well as “Escape from the Central Bank Trap” (BEP). He has been ranked as one of the Top 20 Economists in the World by Richtopia and has over 24 years of experience in the energy and finance sectors.
5-year economic forecasts on 30+ economic indicators for 127 countries & 33 commodities.
Date: May 18, 2017
TagsItaly Eastern Europe Argentina Venezuela Ukraine Nordic Economies Base Metals Commodities Bitcoin Asia Colombia Tunisia UK Spain Healthcare Unemployment rate Euro Area Major Economies Energy Commodities precious metals Inflation IMF Investment Emerging Markets Brexit Portugal USA Brazil TPP Commodities G7 Consensus Forecast Oil Forex Gold Trade Infographic European Union oil prices India OPEC China South Africa Iran Russia Sub-Saharan Africa Banking Sector Canada Cryptocurrency Exchange Rate Precious Metals Commodities Company News Economic Growth (GDP) Housing Market Turkey Japan Africa Mexico France Latin America United Kingdom Greece Australia MENA United States Agricultural Commodities Vietnam Germany
In H2 the Malaysian economy should benefit from strong private consumption. Get our latest 2018 and 2019 growth for… https://t.co/oimkS9OxQS
9 minutes ago
In FY 2018 economic growth in India should accelerate thanks to fading disruptions from the demonetization of Novem… https://t.co/4C9xYnZLQf
3 hours ago
Economic growth in Sub-Saharan Africa is set to accelerate in 2019. Get more details: https://t.co/J6UhL4HDEf
6 hours ago
Despite mounting economic headwinds, the Chinese economy is expected to comfortably meet this year’s growth target… https://t.co/uePHyDNwaK
8 hours ago
8 hours ago
- Which ASEAN countries are most exposed in the event of a U.S.-China trade war?
- 75 Top Economics Influencers to Follow
- Emerging Markets Economic Outlook 2018 and 2019
- The Faces Behind Latin America’s Key Institutions
- 2019 Economic Outlook for the Top Oil Producing Countries
- Is your cup of coffee about to get more expensive going in to 2019?
- The Economic Implications of an Aging Global Population
- Can the Wisdom of the Crowds predict the results of the 2018 World Cup?
- Railway Mania: The Largest Speculative Bubble You’ve Never Heard Of
- From Riches to Rags: Have Cryptocurrencies Crashed for Good?
- Investment looks to Latin America, but forecasts are not encouraging
- Turkey: Erdogan has cemented his grip on power - now what about the economy?
- How can Latin America’s business environment benefit from technological change?
- Mexico: A look at the past, present and future as elections yield AMLO victory
- Italy’s New Populist Government and the Eurozone: Prelude to a Crisis?
- Latin America moves toward increased integration as U.S. protectionism grows
- How can Latin America increase productivity without affecting the quality of employment?
- How will Saudi Arabia's economy benefit from lifting the women's driving ban?
- Which countries are the most prepared for the upcoming digital revolution?
- India Under Pressure from the U.S. on Trade Policy
- The Story of Steel
- Latin America is the World Leader in eCommerce Growth Despite Serious Challenges
- What the TPP means for trade in Latin America
- Elections in Russia: Analysis and Implications
- Nearly a Third of Latin Americans Have No Right to a Pension
- A Look at Healthcare Models Around the World
- The Poorest Countries in the World
- Newly-elected Chilean President Sebastian Piñera faces a myriad of challenges - economic and otherwise
- The Economic Effects of Trade Protectionism
- Regional Disparity: The Dark Side of Inequality in Latin America
- Coal: The story of the world's most abundant fossil fuel
- Gold: The Most Precious of Metals (Part 3)
- Venezuela's Electoral Conundrum
- Trump's 1st Year: 95 Analysts Surveyed on U.S. Economy
- The Latest on China and What's in Store for 2018
- An in-depth look at the Eurozone’s booming economy and the challenges that lurk in the shadows
- Increasing poverty in Latin America takes a breather thanks to improving economic dynamics
- What will be the most miserable economies in 2018?
- The World's Top 10 Largest Economies
- Is Spain doing enough to address its high youth unemployment rate?
- Has Latin America gone far enough in reducing barriers to international trade?
- Commodities Outlook: Oil, Natural Gas, Coal, Lead & Tin
- 21 experts tell us what the future looks like for cryptocurrencies and blockchain
- Turkish lira plummets to all-time low on Erdogan’s monetary feud and tense U.S.-Turkey relations
- Copper: The first metal mastered by man
- The Mercosur-EU Free Trade Agreement: Obstacles & Opportunities
- Nigerian Economy Still Treading Water Thanks to Oil Sector
- Elections in Chile: What the results could mean for the economy
- QE’s Untold Story: A Chart That Fed Correspondents Need To Investigate
- Holland’s fragile one-seat majority government targets economic growth at the expense of fiscal sustainability
- South Africa: Economy at a tipping point?
- Latin American Commodities: What’s behind the increase in demand and prices?
- Is the UK really "shackled to a corpse"?
- Spain-Catalonia: 7 economic experts weigh in on how the situation will affect the outlook
- How well is Spain's labor market doing since the crisis?
- Which countries will have the highest and lowest inflation in 2017?
- How vulnerable is Latin America to economic crises today?
- Iron ore facts and common questions answered
- The bulging economic costs of obesity
- How much investment is needed to salvage Latin America’s crumbling infrastructure?
- A Look at the Potential Impact of Brexit on the Dutch Economy
- Emerging Markets Are Kicking Into Higher Gear In 2017
- Why is foreign direct investment in Latin America falling again?
- Are Central Banks Nationalising the Economy?
- Bounty or burden? The impact of refugees on European economies is far from clear
- What’s the future of U.S.-Latin America trade relations?
- Taxes or cutbacks? Latin America's challenge of sustaining spending without causing debt to skyrocket
- Are uranium prices making a comeback?
- Taxing the Economy: Achieving a Delicate Balance
- How will Latin America’s upcoming lengthy election cycle affect the reform agenda and credit ratings?
- How will emerging market economies perform in 2017?
- Chilean Economy in Focus: Interview with Senior Economist of the Chamber of Commerce of Santiago
- CEOs Rank Top Economies for Growth Opportunities
- The Mobile Ecosystem & Latin America's Economy
- Prospects and Challenges for the Global Economy: Interview with Tim Cooper from BMI Research
- How will the Fed reduce its balance sheet & and how will the ECB end QE? - 19 economic experts weigh in
- Thoughts on "unwinding" QE from Frances Coppola
- The Fed and ECB at a crossroads: Unwinding QE
- Spain: The economy that continues to silence the critics
- Latin America: The Most Unequal Region in the World
- The History of OPEC: Has it been a Success?
- FocusEconomics Announces 2017 Analyst Forecast Awards Winners
- Latin America’s rising unemployment bucks nearly decade long trend
- Escape from the Central Bank Trap by Daniel Lacalle
- China's economic rebalancing act: What to look out for in 2017
- Driving Growth in Latin America: Challenges & Priorities
- Is the Global Economy Rebalancing?
- Commodity exporters face challenging times
- Recent Global Events Facilitate Mercosur-Pacific Alliance
- 23 economic experts weigh in: Why is productivity growth so low?
- Mexico's outlook as Trump nears 100-day mark
- Interview with Oxford Economics Senior Economist on implications of the possible outcomes of the French Presidential Election
- The anxiety of the small saver in a world of negative interest rates
- Brexit negotiations. Between Uncertainty and Urgency
- An Economic History of the EU from El Blog Salmón
- Baby Boomin': Implications of high population growth in Latin America
- Survey of International Economists Predicts a Le Pen Defeat in French Elections, Says Macron has Best Economic Plan
- Spain in a global context: developed economy with some challenges
- How much is crime costing Latin America?
- Predictions & Estimates from Economist Daniel Lacalle
- What economy will the new Dutch government inherit?
- “The data is not a true reflection of reality in India” Interview with Société Générale India Economist
- What are the prospects for Emerging Economies in 2017?
- What to expect in Asia for 2017
- Top Economics & Finance Blogs of 2017
- Latam to Resume Moderate Growth in 2017 but Important Risks Plague Outlook
- 4 Key European Elections That Will Impact the Economy in 2017
- How are security concerns and political chaos affecting Turkey’s economy?
- Global growth to edge up in 2017
- Set to breach targets again? Debt and deficit outlooks for Southern European Eurozone countries in 2016 & 2017
- What does Donald Trump mean for the U.S. economy?
- How will emerging markets perform in 2017?
- The economic impact of a break in U.S.-Philippines ties
- Trump election: Base metals surge due to infrastructure plan
- 5 updates on the Venezuelan economic crisis
- Canada: When your neighbor’s house is on fire…
- Short-term pain before long-term gain? A look at French labor reform and economic growth
- Asia: Unremarkable growth & unfulfilled promises?
- How India's latest monsoon is affecting the economy
- Russian economy update in wake of OPEC deal announcement
- Innovation in Latin America: Potential Goes Untapped Due to Weak Economic Conditions
- The Wisdom of the Crowds and the Consensus Forecast
- Can the peso predict the U.S. election results?
- There's no end in sight to the Venezuela crisis
- A Look at the European Union Political Calendar
- Survey of international economists shows uncertainty surrounding elections damaging U.S. growth prospects
- FocusEconomics partners with leading online statistics provider Statista
- China: Recent postive economic data may be papering over the cracks
- Sub-Saharan Africa's 2016 & 2017 growth rates
- The Italian Dilemma: Weak banks pose risk to already faltering domestic demand
- How much money do migrants from Latin America send home?
- The U.S.' (Not So) Mysterious Case of the Missing Men
- What to expect from the G20 economies by 2020
- The Pain in Spain: Robust GDP growth cannot mask the persistent structural deficit