By Gareth B
In recent months, SARB Governor Marcus has become more outspoken regarding the need for more action to be taken with regards to structural reforms, typically meaning action governmental policymakers should take to enhance the growth and employment prospects of the economy through legislative reforms. Back in June of this year, the Governor said that: “Despite what some would like us to believe, monetary policy is not the panacea for growth…Monetary policy has prevented the global economy from going into a free fall, but it is no substitute for structural reforms that are needed.”
Whilst many of the Bank’s suggestions of actions government policymakers could implement to improve the local economic environment are welcomed and warranted, it can be proposed that SARB accommodation may have ironically contributed to a state of affairs whereby policymakers have been less incentivized to take structural reforms seriously due to the cushioning of cyclically-driven, but unsustainable, growth. It is therefore not surprising to see responsibility for allaying the current malaise being rebounded among monetary and fiscal policymakers. More crucially to consider than inter-departmental buck-passing, however, are the consequences that the SARB’s existing monetary policies have already wrought on another form of structure- that of the economy itself.
Fighting the last war
By utilizing persistent accommodative monetary policies via low policy rates, the SARB has fundamentally altered the capital structure of the economy by impacting upon the time preferences and resource allocation rationales of participants in the economy. This is achieved by creating the impression of a relative abundance of savings by artificially suppressing interest rates, thus supporting a greater extension of credit via the commercial banking system. Whilst a lack of money savings may not be a constraint for credit extension under the current banking apparatus, real resources are in fact scarce. An economy can only expand so far as there are real resources to sustain it. This real resource constraint is what ultimately quells the growth borne from the new credit flowing through the economy. The distortion of the interest rate price signal causes a mismatch of resource allocation across time and space. Somewhere down the line, however, the mismatch is revealed as a cyclical downturn or bust when the misallocations prove to be uneconomical.
The correction to these distortions, a bust, is typically perceived to be undesirable in and of itself. However, the rationale for this bust process is to re-orientate production and allow a society to progress from a sounder economic base. Repeated boom-bust cycles are caused by policymakers trying to end recessions by injecting new rounds of bank credit into the economic system. In a sense then, policymakers are always fighting the last war; trying to win battles against busts by merely permeating the circumstances for the next ones.
Lengthening the capital structure
Capital-based macroeconomics identifies three biases that are prevalent in an environment of artificially low interest rates.
- Consumption is boosted as low interest rates bely a relative abundance of savings and influence time preferences so that many people become more orientated toward present, instead of future, consumption.
- Over-investment in the later stages of the capital structure occurs to serve this consumptive demand.
- Misallocation of capital at the earliest stages of the capital structure also occurs as the low rate environment makes projects that will yield gains in far-off time horizons appear to be more economically viable than they really are.
The capital structure of the economy is thus stretched, with credit-induced demand pulling real resources towards contradictory purposes: near-term consumption and long-term investment for future production/value exploitation. This lengthening is unsustainable because the resource allocation necessary to support the elongated new capital structure exceeds the pool of real resources available. Due to the lack of a savings constraints on credit extension, no commiserate deferment of real resources has occurred to make provision for the new demand. Ultimately market interest rates and prices will adjust to reflect the unsustainable state of affairs and the shortage of real resources will be revealed in the form of a downturn or a bust. This will prompt the adjustment of the capital structure.
Reforming the structure
Viewing the economic cycle in the context of the capital structure of the economy is important because it shows that the ultimate tendency of repeated cycles of credit creation is to generate over-consumption and under-production, and the chronic regression of the economic system. The widespread errors in economic calculation that occur because of distorted price signals from artificially low interest rates sees capital misallocated to ultimately wasteful, un-needed projects along with the generation of inflation. Wasted capital makes society poorer, whilst inflation is a further incentive to consumption at the expense of the savings so needed for reforming the capital structure to a sounder basis. Shallow, aggregated metrics for economic growth such as GDP fail to reflect such important contexts as the intertemporal capital structure of the economy and the way the credit environment is shaping the allocation of resources. But policymakers continue to benchmark their policies upon such metrics without taking into consideration the effects their interventions have on the very structure of the economy itself.
Monetary policymakers would thus do well to consider whether the growth-positive outcomes that could occur from conventional structural reforms would even be desirable in an environment where the structure of the economy itself leads to misallocated capital, inflation and the illusion of relative abundance. These consequences, inherent in the machinations of the cyclically-driven boom-bust cycle, need to be reconciled. Prudent, relatively tight monetary policy should thus not be seen merely as a response for taming the consequences of a boom, but rather as the desirable framework for encouraging lower time preferences, the accumulation of savings and ultimately the reform of the capital structure itself.
Gareth B works as a market analyst and economic observer in Johannesburg. He has also lived and worked in the UK and the USA.