Does the economy drive political outcomes? Who are these key drivers? In an exclusive interview, Matt Klein, Alphaville Reporter at FT Alphaville, shares his thoughts on the key areas of the economy to keep an eye out for, the developments in the central banks and the links between political changes and economic developments.
Which areas of the global economy are you keeping a particularly close eye on at the moment?
The US consumer is the single most important force in the world economy. Over the past few years, American households have sustained their spending even as their incomes have stopped growing. The consequence has been a collapse in the personal savings rate from about 6% to around 2.5%. The positive interpretation is that the decline in savings was overdue and is supported by the boom in asset prices, especially stocks and housing. The negative interpretation is that consumers simply cannot cut their savings rate again by a comparable amount. Income growth is going to have to recover or spending is going to slow down. At the same time, vehicle sales have peaked and credit delinquencies are picking up. I am not saying recession is imminent but I think it is fair to wonder if one of the big growth impulses for the global economy will be missing next year. On the other side of this is the tax cut, which is mostly not going to people who could use the money, but will still be helpful on the margin.
Germany is probably the second-most important economy in the world, because Germany sets the pace for the rest of Europe. For years, the German government has failed to be a responsible member of a monetary union: it has refused to tolerate above-average inflation, it has refused to invest in domestic infrastructure, and it has needlessly overtaxed its citizens. The big question is whether this will change. I see two potential signs for optimism. First, the IG Metall union made aggressive demands on wages and hours and seems to have gotten much of what they were asking for. It is too early to tell whether this will flow through to the rest of the economy and boost overall household incomes but it could be significant. Second, the SDP/CDU coalition negotiations seem to be leaning towards a modest reduction of the government’s fiscal surplus, with useful changes to healthcare, parental leave, and infrastructure investment. I would not overstate the impact of either one of these things but it would be significant if the German economy began to re-balance towards greater household consumption and greater investment in the future.
Finally, there is China. China began gradually moving away from its focus on heavy industry in 2011 and ended up causing a miniature global panic in late 2015/early 2016 by cutting back further on its demand for industrial commodities. The government dramatically reversed course in early 2016 and since then has been aggressively stimulating economic growth in the old familiar (and unhealthy) ways. I am not a China expert by any means, but China experts I follow say we should keep a close eye on who gets chosen to lead the People’s Bank of China once Zhou Xiaochuan leaves office. Zhou has been in the job since 2002 and has stayed several years past his official retirement age.
As a reporter on the economy, do you find you’re spending more of your time looking at politics lately?
Not really. This may be old-fashioned, or a bit Marxist, but I tend to think political outcomes are mostly determined by the economy, with the rest a function of random noise. Besides, there is only so much that governments in constitutional democracies can actually change in any reasonable time frame. When I compare the magnitude of those potential changes against the bigger forces affecting savings, investment, I generally end up thinking of politics as a distraction. The biggest single politically-driven economic shock of the past few years I can think of is Brexit, and even that is mostly just changing a few things around the edges of the UK economy. The fundamental strengths (high employment) and weaknesses (low household savings, big current account deficit) are the same as they were before.
There is one big exception, however: central bank appointments. There are a ton of simultaneous openings at the Federal Reserve Board. How those jobs get filled could make a big difference for the economy in the next few years. Similarly, there is going to be a ton of turnover at the ECB in the next couple of years. We do not know how that is going to play out. Draghi saved the euro, but it was a close-run thing. Who knows what his successor might do? And as I mentioned above, there is a big question about Zhou’s successor at the PBOC (although I doubt you could figure that out by paying attention to news stories on Chinese politics).
As someone who has spent a lot of time studying Alan Greenspan, I’d be keen to get your initial take on new Fed Chair, Jay Powell as he begins his first term, and perhaps how the role has changed since Greenspan’s time.
Let me start by noting there is a common misconception that you need to be an academic expert in monetary economics to be a good central banker. The reality is that many of the best Fed chairmen – Eccles, Martin, and Volcker -- had little to no academic experience. By contrast, Arthur Burns, who is often considered one of the worst Fed chairmen, was a respected scholar before being appointed.
Greenspan, like the best of his predecessors, did not come to the Fed with an academic background. He had taken the coursework necessary for a PhD when he was young but he was not a traditional scholar. Instead, he had made his career as an economic consultant. He was a shrewd observer of the economy and financial system, but he did it without formal mathematical models. In my view, this explains why he was so successful for much of his career. Unlike the ivory tower types who were always trying (and failing) to reduce the complex social system that is the economy to a handful of linear equations, Greenspan focused on mastering the data. He also had long experience trading markets. This helps to explain why he rightly worried about a stock market bubble in the mid-1990s, and why he was relatively early to spot the significant acceleration in productivity growth during the same period.
Perhaps most importantly, he was able to get the job without being seen to have actively campaigned for it, which suggests superior political skills.
Greenspan was also comfortable managing politicians, business executives, and journalists. The Fed may like to think of itself as an apolitical and “technocratic” institution, but it is a powerful economic planning organization operating within the context of a capitalist democracy. This contrast between the reality of the Fed’s (mostly unchecked) power and the way Americans think their society ought to work is dangerous. Handling this tension in a way that preserves both democratic accountability and the Fed’s ability to do its job is not easy, but Greenspan had the skills to pull it off. (Yellen did too, Bernanke less so.)
I know much less about Powell than I do about his predecessors, but what I have read suggests he could be a competent leader of the central bank. Powell does not seem to have Greenspan’s domineering self-confidence in his ability to analyze the economy, but he does seem to have a healthy skepticism of the received wisdom of academic models. His background as a financial executive gives him a useful perspective on what drives risk-taking. Perhaps most importantly, he was able to get the job without being seen to have actively campaigned for it, which suggests superior political skills.
Are you expecting to see a departure in the course set by Janet Yellen?
I am not expecting a meaningful change in the conduct of monetary policy. Almost every Fed official has stressed that their current course was developed as a consensus. Moreover, Powell himself has made a point about the virtue of continuity and dependability. However, Fed officials have long made clear that they set monetary policy in response to their evolving forecasts for the economic outlook (growth and inflation). If that outlook changes, you should expect them to adjust their plans for interest rates.
It is possible that the Fed will become relatively more lax as a regulator. Randy Quarles, the new Vice Chair for Supervision, has made it clear he wants the stress tests to be less stressful. During his confirmation hearings, Powell said his perspective on regulation is similar to Quarles, and also that “too big to fail” had been essentially solved. Particularly relevant for the private equity industry, the Fed seems to have already become somewhat less stringent on enforcing its guidance on leveraged lending limits. My suspicion, however, is that these changes are mostly going to be felt on the margin. Powell was one of the main authors of the Fed’s post-crisis regulations and it would be surprising if he decided to undo all that work.
What do you see are the big issues central banks will have to contend with this year?
Like every year, central banks are stuck with the essentially impossible job of trying to stabilize consumer price inflation without having a clear understanding of how the instruments at their disposal affect the economy and also without any sense of what affects the inflation rate.
More specifically: the Fed is going to have to decide if the tax changes meaningfully affect the economic outlook, the ECB is going to face increasing pressure from Germany and others to bring the Asset Purchase Program to a close, and the BOE is going to have to figure out what is going on with Brexit and how that might affect inflation. The biggest challenges will be at the PBOC, which will have to continue to wrestle with the tensions between its currency policy, capital controls, and credit growth, all without threatening to tank the world economy as it did at the end of 2015.
