Rick Rieder and Russ Brownback highlight their view that effective monetary and fiscal policy in the 21st Century needs to draw not only traditional economic theory, but also from the lessons of finance and other disciplines.
We think the evidence is mounting that the global financial economy has overtaken the global real economy, both in size and in influence. Yet economic policy is struggling to evolve in ways that incorporate more of the traditional theories and insights that are embedded in the study of finance. Thus, to more adequately grasp the economic realities we are witnessing today, we think a merger of these two subjects is required; in higher education as well as in macro analysis. Further, when that more comprehensive view of the economy is married to sound analysis from a range of other fields, such as demography for instance, only then can an investor more appropriately assess the many unprecedented influences that dominate today’s investment landscape.
Learning lessons from Economics, Finance, and other disciplines
Recently, for many market observers, historic rate rallies, ongoing trade tensions and an inversion of the U.S. Treasury yield curve spawned feverish speculation that a U.S., or global, recession is looming. A student in the Economics department would likely argue that the solution to recession fears is to lower global policy rate levels in order to “pull forward” demand, encourage more consumption, or incentivize borrowing for corporate expansion. The flaw in this reasoning is that modern economic theory was developed during a time of unprecedented global demographic growth. When demographically-driven demand was naturally expanding, as it did impressively during the 20th Century, it was far easier to pull aggregate demand forward. In contrast, today’s more tepid demographic dynamics are mandating a more difficult economic growth path. Indeed, aggregate demand curves are shifting to the left today in some regions, meaning that policy makers now face a Herculean task when it comes to pulling demand forward because the equilibrium level of economic output is declining. As a result, we think it’s time to re-think our economic lessons and the “conventional” policy responses.
In our view, a more nuanced policy toolkit is necessary today, combining economics and finance curricula in ways that incentivize new capital investment. A borrower’s desire for incremental capital (to create capacity and invest for expansion) will be catalyzed by three possible drivers: 1) observable aggregate demand growth, 2) harvestable pricing power and 3) potential efficiency gains. Simply lowering interest rate costs only feeds the impulse to invest for growth if at least one of these drivers exists. In a world of aging demographics, aggregate demand growth is limited. At the same moment, technological innovation is destroying any potential for pricing power. Thus, policy makers today should focus on incentivizing investment in parts of the global economy that can actually generate systemic gains in efficiency.