- - Tuesday, April 26, 2016


The global economy is sick and its central bank doctors risk making it sicker. There has been a steady worldwide march toward cheaper credit, in hopes of resuscitating lagging growth. However, this treatment threatens a twofold risk: encouraging moral hazard in the short run and harming the market mechanism in the long run.

In January, the Bank of Japan took the drastic step of instituting negative interest. The European Central Bank followed, taking certain interest rates to zero and instituted negative rates on deposits. While both are extreme, they are merely the vanguard of an ongoing global movement of “subsidized credit” by monetary authorities.

As growth has continued to slow, central banks have leaned ever further forward, exhausting the range of conventional remedies. The subsidized credit cure is just the logical extension of an illogical focus on symptoms instead of the disease. The resulting risk is that formerly short-term emergency measures are becoming extended-term ones, with long-term negative consequences.

Moral hazard is the first threat arising from subsidized credit. The risk of moral hazard increases when the consequences of bad decisions decrease. The more consequences diminish, the greater the threat that risks will be taken.

Contrary to common perception, it is not the excessive risk-taking that is the non-economic decision here — just the opposite: The non-economic decision is the initial one to reduce risk’s consequences.

By subsidizing credit below its true economic costs — even in the well-intentioned desire to stimulate growth — investments’ risk and reward equations swing dangerously out of kilter. With government-subsidized credit, an investment’s risk of failure is reduced, so its de facto return increases. Confronted with subsidized lending, all parties’ logical economic decision is to take increasing risk.

Subsidized credit also has more market-based repercussions.

Subsidized credit distorts market information, just like it encourages risky individual behavior. Properly functioning markets exchange information through the price mechanism. When the price mechanism is distorted — through the subsidization of credit costs and actors’ insulation from the true economic cost of credit, risk and return — the information the market disseminates through prices is distorted, too. The end result is a misallocation of resources, as the economy shifts from its most efficient course.

Once distorted, the market becomes dependent on the subsidies distorting it. Why seek paths other than those encouraged by subsidies offering lower risk and higher return? The process’ final step is market atrophy. Diverted from its proper course, the market becomes unable to pursue another — ceasing to operate as a free market at all.

Subsidized credit’s market-based threats most recently appeared during the financial crisis. Lenders, encouraged to increase housing ownership and then able to offload risk, reaped high returns from doing so. The returns on such low-cost and low-risk activity were disproportionately high. Resources, therefore, poured into that sector and the financial sector that securitized the transactions.

Of course, economic reality stretches only so far before snapping back. When it did — with a vengeance — it revealed an enormous misallocation of resources and, ultimately, wealth destruction.

Ironic indeed that central banks ostensibly aiming for today’s recoveries are following the path of yesterday’s financial crisis — only this time, doing so on a more massive scale, across sectors and continents.

The global economy is indeed hurting. Analogous to sickness, its symptoms are signals — attempts to communicate what ails it. Simply treating symptoms without diagnosing the underlying cause is to condemn the patient to continual convalescence.

The deepening and extending use of subsidized credit is similar to continuing use of painkillers to the point of addiction. There is a place for temporary government action in response to temporary crisis, just as painkillers play a role in allowing a patient’s recovery. However, they are meant to enable treatment; they are not treatment in themselves — means, not ends — and they certainly should not be mistaken for health.

Central banks and their governments are falling victim to dependency on subsidized credit. They continue to measure their efforts in increasingly meaningless — and decreasingly robust — gross domestic product figures that have less and less real growth supporting them.

Though pursued through a variety of forms — both monetary and fiscal policy — these attempts are merely variations on government subsidization of economic activity. It has become the numbing norm, instead of the needed but painful reform. The global economy is increasingly sedated — not healthier — while internally, risk mounts.

J.T. Young served in the Treasury Department and the Office of Management and Budget, and as a congressional staff member.

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