 Williams of the Fed has written about for a long time, et cetera. As you know, 30 years ago that rate, as they calculate it, was 500 basis points, and now it’s—they tend to calculate it around zero. And it’s being used as something that interventionists, as you would say, for very loose monetary policy say, well, we have to keep it very low because the natural rate is low. The question for you is, do you think the rate—the natural rate is so low because of this ongoing intervention that’s been going on for so many years that the patient, essentially, is showing a different symptom profile?
GRANT: Well, I do. One shouldn’t dogmatize about an interest rate that exists only in the imagination of the mandarins of monetary policy. Actually, there is an extensive literature on the natural rate that antedates Knut Wicksell, who died in, I think, 1926. The so-called Austrian school, now mostly associated with Hayek and Ludwig von Mises, talked about a natural rate at which the demand for savings was equal to the supply force savings, not bank credit force-fed into the system through unique and heretofore unimaginable central bank actions, but rather savings—deferred consumption.
ALEXANDER: Can I jump in here?
ALEXANDER: Look, you can make this concept very artificial and whatnot, but ultimately it comes back to a very simple question, which is: What is the relationship basically between growth and interest rates? This whole debate about the natural rate and how you measure it is really just looking at that. Let’s look at the last six months. The last six months, the U.S. economy has grown at about 1.1, 1.2 percent, with real rates that are essentially zero. I would argue that 1.1 is almost certainly below anybody’s estimate of what potential is. So the normal definition of the neutral or natural rate that is commonly used in the monetary policy debate is what is the level of interest rates that gets the economy to grow at potential? It’s a very simple observation to say that whatever that rate is, it’s in some sense lower than where rates are now.
And when the Fed talks about that, that’s ultimately the issue they’re talking about. And I think when you—when you seriously try and look at how the economy’s behaved over the last five years, it’s hard not to draw the conclusion that that relationship between interest rates and growth is very different from what we had before. Now, I think what you’re seeing in the discussion around these issues within the Fed is struggling to understand why that’s the case and to try to project forward, you know, how is that going to happen going forward? I would argue part of the problem with the Fed over the last five years has been they have been too optimistic about the recovery. What you’ve seen consistently is them overestimating growth and overestimating the path of rates that the economy could accommodate. Ultimately, that is about the path of this very simple concept.
Going forward, what’s going to matter? I think the simple way to think about the way the Fed is going to behave is they’re going to see how the economy responds. If the economy picks up, that implies that in some sense it can handle higher rates and they can raise rates. If it does not, they won’t. It’s really that simple. And in some sense, you can—you can make this a bigger deal than it is. But ultimately it’s about the very simple relationship between growth and the level of rates.
DINSMORE: And I think on that point, in terms of the Fed overestimating growth, I think at the end of the day economic growth as a whole boils down to confidence. And if people are confident enough to invest, if businesses are confident to invest, then you start seeing that. And I think that a lot of the Fed’s—I would agree the Fed has been overly optimistic. But I imagine the counterfactual, in which Janet Yellen says that she was tremendously concerned about the outlook for the U.S. economy and they didn’t have this level of optimism baked in, I think that would be disastrous for confidence. And I think that that also goes back to the question about exceptional monetary policy, and we talked about that in the ECB and the euro. I wonder in the absence of the ECBs intervention, which I agree has been quite unprecedented and exceptional, what really would the European economy look like?
GRANT: Yeah. Well, we talked about growth, which is an income statement concept. But we also ought to talk about leverage, which is a balance sheet concept. And if the Fed insists on pressing down rates, or at least not lifting up rates, or doing what it’s doing, I guess, is the way to think about its policy—if the Fed insists on persisting, it seems to me we will see a great deal more of what we are currently witnessing, namely the incurring of debt to generate income that is not there in the natural level, or the observed level of interest rates, the nominal rates.
What you don’t see is what is going on with the balance sheet side of things. You can observe it at intervals, but I think there is a preoccupation on growth to the detriment of our awareness of the dangers that heightened leverage to induce—or produce income artificially, what that goes to finance, and the kind of crises it introduces and the kind of responses to those crises.
MALLABY: Another question? Otherwise I’ve got a question. Oh, I see one over here, OK. Here, and then you.
Q: I’m sorry. Arthur Rubin with SMBC Nikko.
One of you observed that if Brexit were to occur, that only would the pound head down, but it would probably have a negative impact against the euro. There’s a finite number of things that they can go down against, which implies an even stronger dollar. The Fed—various members of the Fed have been vociferous in saying that they’re not going to make their decisions based on what’s happening to the dollar in the rest of the world, yet it’s hard not to believe that at some level there’s kind of a veto over what the Fed does by where the dollar is. Do you think that a Brexit should occur, and if it did have this knock-on effect on both the euro and the pound, what does that mean for the Fed’s decision making policy and the impact of the dollar rates? For anybody.
DINSMORE: Well, I think if that happens you’re going to see easier monetary policy across the board. No country is supposed to—no central bank is supposed to explicitly target their currency as a policy lever, but obviously currencies influence inflation. And so it can’t be ignored. A stronger dollar is one of the biggest headwinds, I think—or potential upside risks—or downside risks of inflation in the U.S. And you would most certainly see concerns—or, renewed concerns about the inflation outlook for the U.S. if the dollar breaks much higher from here. And really, I think, as you look at the Fed’s concerns about inflation—so their two concerns about inflation had been low oil prices and a strong dollar. And the base effects of those on a calendar year basis are scheduled to roll off, and so you actually should see some inflationary pressures. But if you see the dollar spike again, that’s going to renew this disinflationary concern, and certainly I think would prompt Fed members to be hesitant to raise rates.
Q: Teresa Barger from Cartica Capital, visiting from Washington, D.C.
I would just love it if you could talk about two things. One is productivity. Pre-GFC, it was growing for 50 years at 2.5 percent, and since at 0.5 percent. That’s a U.S. number. I don’t—but similar in Europe and similar in the emerging markets. We’ve had a real stepdown in productivity. And where do you see we might get out of that? And the related question is with margins. Corporate margins have come down. I, of course, only know the emerging markets, but it’s also true in the U.S. And are we seeing any green shoots of an uptick? And where will that come from?
MALLABY: Go ahead then.
Q: Over 50 years too.
ALEXANDER: Well, but what you, in fact, had was relatively high productivity growth until around the mid-’70s. It then fell quite dramatically. We had a little bit of a recovery starting in the mid-’90s that lasted for a decade or less. And that’s kind of where you get that average, but in fact it’s not literally constant. In some ways what’s happened is we’ve come back to those lower levels we saw in the ’70s and, frankly, lower levels that we saw before the 1920s. This is—there’s a lot of interesting work that’s going on on this subject at this time. There’s a book by Bob Gordon, who I—it’s a little too long. It could have used an editor. But it’s actually a very good book.
I think there are good reasons to expect low productivity growth as something where it’s here to stay. It’s not that there aren’t positive things going on, but I think they’re less broad than they used to be. One of the simple ways to think about