So, what’s “secular stagnation?” You’ve read a lot about it in recent FedFin analyses of high-profile papers from top-flight policy-makers, but most are loathe to explain this bit of in-the-know jargon lest anyone question their expertise. Does it mean the spiritual quagmire in which atheists may find themselves on bright, sunny days? A bad day at the seminary for doubting clerics unable to conclude endless debate? Nope – it’s instead the academic moniker for what the IMF managing director more clearly called the “new mediocre” — persistent slow growth and looming deflation. Some of this mediocre mess comes from demographic changes, geopolitical risk, and Groundhog-Day fiscal policy. However, the growing asymmetry between financial rules and financial markets also plays a critical, frightening role.
In secular stagnation, things aren’t all that bad at least for most of us, but they’re far from good, especially for those who most need better times. Slow job growth, modest GDP increases, and iffy productivity are all signs of secular stagnation, as is the constant potential for deflation because accommodative monetary policy designed to stoke real growth collides with obdurate structural and market counter-forces that drive ever-desperate yield-chasing to make ends meet. Combine macroeconomic factors with the post-crisis reform framework and you get potent procyclical drivers fired up by the inability of banks to dampen them with liquidity facilities, capital buffers, and the like.
A paper from the Federal Reserve Bank of Boston is among the clearest on this quandary. Largely a literature survey, it assesses the degree to which monetary policy can be transmitted through traditional channels – read banks – to do what needs to be done to promote both growth and price-stability. Based on its read of the literature, the paper concludes that money now travels so freely outside of banks that policy designed to slow or speed it are dulled unless or until a crisis reminds money-holders why banks are stores of value. Flooded then with funds, banks struggle to deploy them, in part due to tough new capital requirements, creating huge pools of low-yielding funds that are unwilling (investors) or unable (banks) to fuel economic growth until investors grow so desperate that they chase yield all over again even though caution tells them to be more careful.
And, so goes the cycle – funds flee banks that can’t beat negative real rates until flight-to-quality incentives open the flood gates, leaving banks awash with funding they can’t deploy for profit due to the combination of new rules and depressed growth.
Does this mean that “shadow” banks are bad? Far from it. As a paper this week from the IMF rightly says, non-bank liability providers counter-balance banks, providing what the study called a “spare tire.” However, if artificial policy incentives force funds out of banks to chase yield and back into banks when yield is the last thing on the minds of panicky investors, then financial markets are subject to profound asymmetries with structural and systemic ramifications.
Naming one or another “shadow” firm as a SIFI, subject to whatever rules the FRB or other regulators come around to crafting for them, will do nothing any time soon to realign the balance of market incentives and financial-system rules. Indeed, in the near term, it will make asymmetry worse because only a few firms will be targeted, leaving the rest of the non-bank sector even more empowered because the regulatory burden imposed on banks means that they cannot rebuild capacity shed by a SIFI. Ask yourself, for example, where the $500 billion in finance GE plans to shed will go and see how real this quandary has already become. Under stress scenarios, it will be still worse.
Do we know what activities in or out of banks create not just the new mediocre, but also the thin reed on which financial stability rests? What’s most striking about all of these studies is how little there is in them on remedies to the ills they all too clearly document. Maybe times will get better and the balance will realign back to a reasonable one between banks backed by taxpayer benefits and non-banks that aren’t. But for as long as investors are blinded to risk by asymmetries that force desperate action, low-return policies can turn into high-volatility, deep-illiquidity ones all too fast and all too soon.