OECD calls on countries to borrow and increase public capital spending
On Thursday, the markets widely expect the ECB to move its official deposit rate deeper into negative territory, cutting it to possibly as low as -0.5% writes Oliver Mangan Chief Economist atAIB.
Last month, the Bank of Japan moved rates into negative territory, while central banks in countries such as Switzerland, Denmark and Sweden have had negative rates for quite some time. It is hard to believe that seven years after the end of the Great Recession of 2008-09, there is no end in sight to the policy of zero or negative interest rates, with both markets and central banks still focused on the downside risks to growth and inflation.
Even in economies such as the US and UK, which have seen reasonable recoveries and are approaching full employment, interest rates are expected to remain pitched at near zero. The recently retired president of the Federal Reserve Bank of Minneapolis, Narayana Kocherlakota argues that negative interest rates are the result of a “gigantic” failure of fiscal policy.
He believes going to negative rates is the appropriate monetary policy but it is also a sign of a terrible failure by fiscal policymakers to take advantage of very low long-term interest rates. Governments, he argues, should be willing to act on the fact that investors are willing to buy their debt at very low interest rates and use the proceeds to undertake worthwhile public investment. The OECD and IMF are also coming around to the same view. In its latest Economic Update, the OECD says there is a need to strengthen demand in economies but monetary policy cannot work alone. Like Mr Kocherlakota, it argues that governments in many countries are able to borrow long-term money at very low interest rates and have the room for fiscal expansion to strengthen demand.
The OECD is calling on countries to increase public capital spending in particular. Investment spending has a high-multiplier effect which means it has positive spillover effects on the rest of the economy. Worthwhile infrastructure spending also helps to support long-term growth, as well as bringing short-term benefits in boosting activity levels. Meanwhile, last week, Christine Lagarde, managing director of the IMF, called for greater policy actions to boost global growth, including more supportive fiscal policies via “making the best possible use of fiscal space for example, through infrastructure spending”.
It may have taken them a good part of this decade to come around to the view, but it seems that policymakers are now realising that a more expansionary fiscal policy is required globally, if the recovery in the world economy is to be put on a more secure footing. The EU Commission had a lot to say about public capital spending in a detailed working paper that it published on the Irish economy last week. It notes that seven years of austerity have taken their toll on the quality and adequacy of Ireland’s capital infrastructure.
Public capital spending has fallen from over 5% of GDP in 2008 to about 1.5% in recent years. This is around half the level in the rest of the EU and US. Capital spending on transport and housing have suffered the biggest cutbacks in the past decade. Unsurprisingly, the Commission identifies housing, water services and public transport in particular as facing interconnected challenges. The Government’s Capital Investment Plan for the next five years envisages just a modest rise in capital spending.
“This could affect not only Ireland’s growth potential but also the delivery of key public services” says the Commission. The Commission also argues that infrastructure spending needs to return to the forefront of public policy. This means that increases in public capital spending should take priority over tax cuts and higher spending on services. Indeed, with the budget deficit likely to be almost eliminated this year, there is a strong argument in favour of borrowing at the current, low, long-term interest rates for capital projects, especially those that can generate an income.