The world's in a 'global liquidity trap'. What does that mean for Australia?
Last week, something notable occurred.
Two days out from the US presidential election, the chief economist of the International Monetary Fund issued a warning.
She said the global economy was in a "liquidity trap".
"For the first time, in 60 per cent of the global economy — including 97 per cent of advanced economies — central banks have pushed policy interest rates below 1 per cent. In one-fifth of the world they are negative," Gita Gopinath warned.
"With little room for further rate cuts, central banks have deployed unconventional methods.
"Despite this effort, persistently low inflation — and in some cases intermittent deflation — has raised the spectre of further monetary easing to achieve negative real rates if another shock strikes.
"It has led to the inescapable conclusion that the world is in a global liquidity trap, where monetary policy has limited effect.
"We must agree on appropriate policies to climb out," she said.
Ms Gopinath's warning was published in the Financial Times, the 132-year-old organ of the world's financial elite.
A day later, the Reserve Bank of Australia cut its cash rate target from 0.25 per cent to 0.1 per cent — the lowest in our history.
It also launched a $100 billion "quantitative easing" program to drive down interest rates across the whole structure of Australia's economy, and to depress the value of Australia's dollar.
The day after that, the US presidential election took place and much of the world's attention has been fixated on the results of that historic election ever since.
But we'll have to come to terms with Ms Gopinath's warning — because if she's correct, the implications for Australia could be profound.
So, what's a 'liquidity trap'? And how will it affect Australian households?
Essentially, a liquidity trap is a situation in which interest rates become so low that monetary policy has limited effect.
We've seen evidence of the phenomenon here.
For the past nine years, the RBA has been consistently cutting interest rates.
The cash rate target was 4.75 per cent in 2011, it's now 0.1 per cent, but inflation has been weakening for years.
And last week, the RBA announced it would start buying hundreds of billions worth of Government bonds to pull interest rates lower, and to weaken the currency.
This is another sign of the liquidity trap.
"There is … greater risk of currency wars in a global liquidity trap," Ms Gopinath warned in her Financial Times op-ed.
"When interest rates are near zero, monetary policy works to an important extent by weakening currencies to favour domestic producers.
"[But] with the pandemic already testing the limits of multilateralism, the world can ill-afford the escalation of tensions that competitive devaluations are likely to generate."
How do governments get out of this situation?
Ms Gopinath says it will take a coordinated global effort.
She says governments must work together, using their spending power, to re-energise demand on a global scale. They must avoid currency wars.
"It is time for a global synchronised fiscal push to lift the prospects for all," she said.
Of course, she's not the first person to say so.
In October last year, in a speech to the IMF, a former governor of the Bank of England, Mervyn King, criticised the current generation of policymakers for failing to concede how much the world had changed since the global financial crisis.
He wanted them to acknowledge that the world's advanced economies (including Australia's) had been stuck in a "low growth trap" for at least a decade.
He said policymakers were clinging to a particular model of how monetary policy operated, and it was leading them to misdiagnose our current economic problems.
He believed the global economy was suffering from a sustained lack of demand, and countries would have to work together to reallocate resources around the world to revitalise demand.
"Escaping from this low-growth trap is a different proposition than climbing out of a Keynesian downturn and requires
different remedies," he said.
Other economists have also been onto this problem.
In fact, Larry Summers, a former secretary of the US Treasury, started the conversation in 2013 when he asked publicly why advanced economies had been struggling to grow since the GFC, and why inflation was so low, when interest rates were nearing zero and the world was awash in savings.
"All this requires new thinking and new policies, much as the rapid inflation of the 1970s forced a reset back then," he then argued last year (also in the Financial Times).
"Today's core macroeconomic problem is profoundly different from the problem any living policymaker has seen before.
"What is to be done? To start with it would be helpful if policymakers acknowledged … that the policy problem is not smoothing cyclical fluctuations or preventing profligacy.
"Rather the fundamental issue is assuring that global demand is sufficient and reasonably distributed across countries."
If their combined analyses are correct, there will be implications for Australia.
It means interest rates will be near historic lows for years, and governments will shoulder the majority of the burden for re-inflating the economy — rather than the RBA.
Federal and state and territory governments will be able to borrow at the cheapest rates in history, but they'll still have to spend the money wisely, otherwise they could do more damage to the economy in the long term.
"Fiscal policy must play a leading role in the recovery," Ms Gopinath said.
"The importance of fiscal stimulus has probably never been greater because the spending multiplier — the pay-off in economic growth from an increase in public investment — is much larger in a prolonged liquidity trap."
But there's a problem here.
See how governments are facing a collective action problem?
We have the chief economist of the IMF, a former governor of the Bank of England, and a former US Treasury secretary all saying global leaders will need to work together to pull the world's economies out of this low growth, low interest rate, high debt trap.
But just last week, the RBA began a multi-billion-dollar bond buying program to drag Australia's interest rates lower, to keep the value of Australia's dollar down.
It's pursuing the same strategy as other countries: competitive currency devaluation.
That's the opposite of what's advised.
But it has no choice (at the moment).
In a world of open trade and near-zero or negative interest rates, if other countries are dragging their interest rates even lower and Australia doesn't follow them, Australia's dollar will strengthen and it will hurt our domestic producers.
So what's the end-game?
Australian policymakers haven't articulated one.