Noted bubble expert Nouriel Roubini, professor at NYU’s Stern School of Business and chairman of Roubini Global Economics, channeled PIMCO’s Bill Gross late last month by employing a soup metaphor to warn of economic woes to come.
The problem, Roubini noted, is the tradeoff between restoring robust growth and maintaining financial stability. The former requires policies that would potentially lead to economic bubbles while the latter does little to stimulate employment.
He begins by noting the alphabet soup of measures central banks been “served up” in recent years: ZIRP (zero-interest-rate policy); QE (quantitative easing, or purchases of government bonds to reduce long-term rates when short-term policy rates are zero); CE (credit easing, or purchases of private assets aimed at lowering the private sector’s cost of capital); and FG (forward guidance, or the commitment to maintain QE or ZIRP until, say, the unemployment rate reaches a certain target).
“And yet, through it all, growth rates have remained stubbornly low and unemployment rates unacceptably high, partly because the increase in money supply following QE has not led to credit creation to finance private consumption or investment,” Roubini wrote on the Project Syndicate website.
Instead, he added, banks have hoarded the increase in the monetary base in the form of idle excess reserves.
“There is a credit crunch, as banks with insufficient capital do not want to lend to risky borrowers, while slow growth and high levels of household debt have also depressed credit demand," he writes. "As a result, all of this excess liquidity is flowing to the financial sector rather than the real economy.”
Indeed, Roubini argued, the U.S. stock market and many others have rebounded more than 100% since the lows of 2009; issuance of high-yield junk bonds is back to its 2007 level; and interest rates on such bonds are falling.
“The collapse from 2007 to 2009 of equity, credit and housing bubbles in the United States, the United Kingdom, Spain, Ireland, Iceland and Dubai led to severe financial crises and economic damage.”
So, are we at risk of another cycle of financial boom and bust?
The trouble is that if macroeconomic policies advocated by central banks don’t work, the interest rate “would have to serve two opposing goals: economic recovery and financial stability. If policymakers go [slowly] on raising rates to encourage faster economic recovery, they risk causing the mother of all asset bubbles, eventually leading to a bust, another massive financial crisis, and a rapid slide into recession.”
If they try to prick bubbles early on with higher interest rates, he countered, they will crash bond markets and kill the recovery, causing much economic and financial damage. It’s a case of “damned if they do and damned if they don’t.”
“For now, policymakers in countries with frothy credit, equity, and housing markets have avoided raising policy rates, given slow economic growth,” he concluded. "With asset prices continuing to rise, many economies may have had as much soup as they can stand."
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