Andrew Sentence is a former member of the Bank of England Monetary Policy Committee, the body responsible for setting UK interest rates. He is now Senior Economic Adviser at PwC and his latest book Rediscovering Growth, is part of the Perspectives series.
He spoke to the Prospector on a range of economic subjects, ranging from domestic concerns to macroeconomic policy. What follows is the concluding section of that interview
Jay Elwes: Are you worried by what is happening in emerging markets, including Turkey, China and Argentina? Do you see a re-ordering here?
Andrew Sentance: There are a number of things going on in emerging markets at the moment. First of all, I don’t think anybody can really put their hand on their heart and say they expect to see fast growing economies like emerging markets that don’t have economic cycles. So we have to allow for the fact that economies will have cycles, even if they have faster rates of growth on average, they’ll have some periods when that is particularly strong, and then they will have other periods of weaker growth. And part of what’s happening in China is to do what that. China, I think, has strong economic fundamentals with some cyclical movements. But they have said that they want to get their longer-term growth rate down to more sustainable 7.5 per cent, and I think that’s a recognition that as the development of the economies continues, growth rates do tend to slow down (if they continue to develop satisfactorily).
So that’s one thing—we’re bound to see cycles in emerging markets. I think the second thing that’s happening is perhaps we should be more discriminating when we look at emerging markets; not all emerging markets are the same just as not all western economies are the same. Some Western economies have potentially better growth than others. The United States and Northern Europe potentially have better growth potential than southern Europe at the moment. Hopefully southern Europe will come through some of its problems. And so there will be emerging markets from time to time that have less good growth fundamentals or where there are broader political-economic problems that haven’t been solved.
We’re also seeing examples of emerging markets where infrastructure developments or other aspects of the economy haven’t kept pace with economic growth. So if you take India as an economy which needs a lot of infrastructure investment, part of its challenge is to put in place the infrastructure that will support growth. That’s been less of a problem in China where they’ve invested heavily in infrastructure in recent years.
So we need to be more discriminating in our view of emerging markets. My view of the emerging market phenomenon is that it is fundamentally driven by the Asia Pacific region becoming the dominant region of the world economy, because it is home to these very large economies with quite considerable growth potential like China, India and Indonesia. It’s home to 60 per cent of the world’s population. And if you look at the origins of emerging market growth, it really started with some of the small east Asian economies like Korea, Singapore, Taiwan and Hong Kong which were studied by the World Bank in the mid-1990s and the policies they pursued have been taken up and adapted by large economies like China and India.
So growth in emerging markets is always conditional on there being good economic policies. If good economic polices are not being pursued or there’s political instability, then there’s always threat to growth wherever that happens.
JE: To what extent has tapering by the Fed driven problems in Emerging Markets?
AS: The Fed should be creating more stability and confidence around its policies. I do think it should be winding down its quantitative easing policies. I have felt for some time that those policies have been overused, and they’ve started to create as many adverse effects as beneficial effects. In fact probably more adverse effects, so at a global level, keeping on pumping liquidity aggravates the upward pressure on energy and commodity prices and global inflation trends more generally, and global asset market trends, which is not healthy for a long-term sustainability of growth in the world economy.
Some time ago, we reached the point where the US and the UK no longer needed to keep generating more stimulus and the UK’s QE policy stopped in 2012. I think the US should continue down the track of winding down its QE policies. And, ultimately, I think in the US and UK we should see rising interest rates. Perhaps we should see the first steps on that path quite soon. That wouldn’t be a bad thing, but markets adjust to what happens relative to what they expect, so you have to prepare expectations properly. And one of the problems we’ve had in the States is they have been oscillating between whether they are going to pursue a tapering policy or not, creating uncertainty around the policy and adding to market volatility. So I would like to see more confident handling by central bankers in this process of managing the exit from the extreme emergency monetary policies that were put in place in 2009, and I think there has been a bit of a tendency to try and hang on to these policies too long and not to start preparing for the period when we move away from them.
JE: Forward Guidance was an attempt to manage expectations in this way. Has it been used well?
AS: Well I think central bankers, including the Bank of England, have used Forward Guidance wrongly. They’ve used Forward Guidance to somehow perpetuate the view that monetary policy will be continuing on a very expansionary track, whereas they should be using Forward Guidance to prepare the ground for the withdrawal of some of this monetary stimulus. Then, even if interest rates go up a bit, and we’re not having Quantitative Easing, it still leaves, by historical standards monetary policy in an expansionary position. The question is not whether we want to create tight monetary policy—that would be inappropriate in current circumstances. But we should ease off some of the stimulus that has been provided because the situation of the world economy and of national economies is changing.
JE: When do you think interest rates might go up?
AS: I think the Bank of England should already be preparing the ground for rising interest rates. They’ve been drawn into that position slightly accidentally because their attempt to say “we won’t review interest rates for a while” was linked to a 7 per cent unemployment rate. While the Bank thought it would take until 2016 to get there, we’re almost at this threshold already.
If I had my own ideal recommendation, it would be that interest rates should start rising this year, but in a way that is seen as a gradual transition, not as a shock. I think the danger is that by emphasising too much the need to keep interest rates very, very low, it then becomes a shock even if they do rise even by a small amount, that’s not really a healthy position.
Central bankers need to shift their emphasis now. They’ve done an awful lot of work to support growth. As growth returns then their job is to make sure we can manage that recovery, and we can move to a more balanced monetary policy that isn’t so extremely favourable towards borrowers.
JE: Growth is returning here in Britain—but is there still a risk from the Eurozone?
AS: I think we’ve got through the worst phase of the euro crisis. But I don’t think you can say the euro crisis is over because there are various aspects of it that still have not been properly resolved. First of all I think there are longer-term structural issues—that I talk about in my book—in the southern European economies which are going to take a number of years to address.
I see a two speed Europe between northern and eastern Europe and southern Europe, with France also having relatively disappointing growth compared with northern Europe.
Secondly, the euro area governments are still in discussions about a banking union and making sure that bank regulation is put on a European basis—that process is still incomplete, still work in progress. And thirdly, in terms of the management of economic policy in the EU and the euro area in general, the European Union created a single currency zone but it’s clear that there are other areas of economic policy that need to be managed in a more integrated joined-up way. It’s still not clear that we’ve got the right European processes for doing that, particularly in the euro area where countries are constrained by having to operate under the same monetary policy.
So hopefully with an improving global economy, the United States picking up and the UK recovering, the euro area and the EU will continue to manage their way through those issues. We should be past the worst phase of the euro crisis and things should gradually improve. But we can’t just say everything’s sorted, let’s go off and worry about something else.
I do think one thing that could help the euro area is that the euro has been relatively strong against the dollar and other currencies, even despite the euro crisis. And in an environment where other economies are starting to perform better in terms of growth, like the US and UK, that could well lead to the euro depreciating against the dollar and other currencies. A more competitive currency may provide some more support for growth in the euro area over the next few years.