Comment | European Bank for Reconstruction & Development


Seeing the investment light Stuart Trow


Stuart Trow is credit strategist at the European Bank for Reconstruction & Development


At long last, people are starting to talk about sen- sible policy alternatives to the mindless monetary orthodoxy of the global central banks. Monetary policy is a valuable stimulus tool. But it works in much the same way as an adrenaline shot. It’s great for reviving the patient, but is hardly a long-term treatment plan. The Fisher hypothesis essentially has it that mon- etary actions will have no effect on the real econ- omy over the longer term. Yet the broader impact of monetary easing is not so benign. Whatever the effect on the real economy, there is no doubt that asset prices do respond to cuts in nominal interest rates. Moreover, low nominal rates bestow their bene- fits unevenly across the economy. They dispro- portionately favour those who are already asset- rich or have sufficient income to be granted loans at favourable rates. These people generally have extremely low marginal propensities to consume.


Once expectations of low nominal rates become embedded, people tend to eschew traditional investment in the real economy in favour of financial assets, such as securities and real estate, that offer a capital gain. That is why, for example, positive convexity, long- term bonds are so attractive, despite the minimal yields on offer. Austria’s infamous 2117 “century bond” may carry a coupon of just 2.1% and yield a mere 99 bps, but in August it traded as high as €214 having been issued at par less than two years earlier. Yet for all this monetary accommodation, the ECB also played fiscal hardball.


Indeed, its blunt fiscal controls led to a degree of austerity that would have made even former UK Chancellor George Osborne blush. So given the failure of monetary easing and fiscal austerity to do anything other than distort asset markets and depress growth, why don’t we sim- ply let governments spend?. The answer is that, unless you are very careful, the impact of fiscal stimulus just ends up being as temporary as the monetary kind.


There are though signs of emerging enlightenment.


Amid weak macroeconomic data, the German government is discussing plans to set up inde- pendent public investment agencies. These will capitalise on current low interest rates by invest- ing in public infrastructure and climate protec- tion


measures outside the restrictive


straightjacket of national spending rules. This so-called “shadow budget” would barely scratch the surface though. The German state-owned development bank KfW estimates that the pent-up demand for pub- lic investment in Germany is some €138bn (£118bn). Nevertheless this would be an impor- tant first step in acknowledging the need for gen- uine state investment. In Europe, though, there is a further problem. We have industries that were world leaders a few decades ago, but have been somewhat overtaken in recent years. As a community we desperately need investment to step up to the next level to compete globally. If we don’t, Germany’s slow- down might simply be a foretaste of the stagna- tion to come.


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14 | portfolio institutional | November 2019 | issue 88


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