Can Accommodative Monetary Policies Help Explain the Productivity Slowdown?

IMF News, January 10, 2018

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Can Accommodative Monetary Policies Help Explain the Productivity Slowdown?

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• Published: January 10, 2018

Key messages (preview)

• While the productivity slowdown is largely a secular phenomenon, the GFC amplified it by creating “productivity hysteresis” through long-lived adverse effects on credit conditions, aggregate demand, economic uncertainty, and investment.
• Monetary policies have probably had unintended side effects on the recent productivity growth experience, but the magnitude and sign of these are unclear — these unintended consequences may well add up to a positive overall effect.
• Even if very low interest rates maintained for long periods turned out to have exerted a drag on productivity growth, that finding alone would not justify premature monetary-policy normalization; the costs of tightening would likely be large and targeted financial-sector measures are the preferred first line of action.

Remarks by Maurice Obstfeld, IMF Economic Counsellor and Director of Research, Joint BIS-IMF-OECD Conference on Weak Productivity — January 10, 2018

Magnitude and scope of the slowdown

• Between the 2000-2007 and 2011-2016 periods, total factor productivity (TFP) growth:
  • dropped 0.7 percentage point (from 1 to 0.3 percent) in advanced economies
  • dropped 1.5 percentage points (from 2.8 to 1.3 percent) in emerging and developing economies
• The above figures exclude the 2008-10 crisis period, during which productivity naturally plummeted.
• For advanced and low-income countries, the sharp deceleration in TFP occurred on the back of a slowdown that had already started prior to the crisis.

Main drivers of the productivity slowdown (advanced economies)

• The slowdown is “undoubtedly, and mainly, a secular phenomenon” predating the crisis; literature focuses on innovation, technological diffusion, and measurement issues.
• Crisis-related amplification (“productivity hysteresis”) documented for at least three interrelated reasons:
  • Weak corporate balance sheets and persistently tight credit conditions undermined TFP growth, partly by constraining investment in intangible assets by distressed firms.
  • Despite extraordinary policy stimulus, aggregate demand remained sluggish for close to a decade, inhibiting investment and technological progress.
  • Elevated economic and policy uncertainty plus higher risk aversion in the wake of the crisis attenuated TFP growth by tilting investment away from higher-risk, higher-return projects.
• Cross-regional heterogeneity:
  • The three crisis legacies were less severe in the United States than in Europe; the post-crisis productivity slowdown has been sharper in Europe.
  • In parts of Europe, weak banks may have “evergreened” loans, contributing to a rising share of “zombie firms” between the late 2000s and the mid-2010s, with adverse effects on capital allocation and productivity.

Has accommodative monetary policy played a role?

• Supporting channels (positive effects):
  • Aggressive monetary policy eased credit conditions and softened the blow to investment, mitigating hysteresis.
  • Monetary accommodation facilitated access to credit for viable but vulnerable firms and alleviated an even larger drop in aggregate demand and investment.
• Potential offsetting channels (negative effects):
  • Prolonged low interest rates could increase capital misallocation by making more projects nominally profitable while credit-constrained firms cannot respond symmetrically, raising dispersion in the marginal product of capital across firms.
  • Easy conditions may have amplified “zombie firm” dynamics by enabling weak banks to evergreen loans and weak firms to stay alive by borrowing.
  • Elevated asset prices (notably housing) might draw resources into low-TFP sectors like construction.
• Cross-country evidence and magnitude considerations:
  • There does not appear to be a widespread rise in capital misallocation across advanced economies; many northern European countries show no noticeable increase in dispersion in marginal products of capital since the crisis.
  • There does not seem to be a broad-based rise in the share of capital sunk in “zombie” firms across advanced economies; country-specific factors (bank balance-sheet consolidation, insolvency regimes) likely matter more.
  • A careful recent OECD study estimates a potential one-off TFP level gain of about 0.6 percent from resolving zombie firms (broad definition for year 2013, assuming costless reallocation). By comparison, 0.6 percent is about one year of the TFP losses advanced economies have been incurring each year since 2010 relative to the pre-crisis trend.
  • It is unclear what share of potential gains from resolving zombie firms could be reaped through monetary policy alone.

Policy implications and recommendations

• Overall stance on monetary normalization:
  • Current knowledge does not support earlier monetary normalization solely to address productivity side-effects for two main reasons:
  • The optimal response to misallocation driven by market and policy failures is to address those failures directly (targeted financial-sector and structural reforms), not to rely on monetary tightening.
  • Monetary tightening sufficient to force restructuring would likely entail large output and job losses and risk undermining inflation objectives and central bank credibility.
• Recommended direct policy actions (especially where zombie lending is an issue):
  • More robust banking sector supervision with enhanced loan loss provisioning.
  • Improved bank resolution regimes to enable speedier, less disruptive consolidation of weak banks.
  • Deeper and more developed distressed-debt markets.
  • Reform of insolvency regimes to facilitate corporate restructuring.
  • Further progress on these fronts would encourage fresh corporate investment and reallocate capital toward productive firms, including young and innovative companies.
• Cost-benefit perspective:
  • Example calculation: If the Bank of England’s policy rate had been maintained at 4.25 per cent rather than 0.25 per cent, productivity levels might have been 1 to 2 percent higher by 2014, but there would have been 1½ million fewer jobs, representing about 5 percent of total U.K. employment (Haldane, 2017).
• Operational challenges:
  • It is unclear how monetary policy could be operationalized to target productivity side-effects in quantitative terms; doing so risks volatility in inflation expectations.
  • There is a parallel with the debate on “leaning against the wind” for financial stability: better-targeted micro- and macro-prudential tools are preferred, and required tightening would likely be significant with uncertain gains.

Concluding policy guidance

• The current cyclical upswing presents an opportunity to implement measures to support future productivity growth, including:
  • Addressing crisis legacies through financial-sector measures.
  • Innovation and education policies.
  • Structural reforms to revive productivity growth.
• Premature monetary policy normalization is not recommended as a primary tool to counter weak productivity growth.

Source: Remarks by Maurice Obstfeld, IMF Economic Counsellor and Director of Research, Joint BIS-IMF-OECD Conference on Weak Productivity: The Role of Financial Factors and Policies, January 10, 2018.

References

• Maurice Obstfeld
• Japan and the IMF
• United States and the IMF
• Speeches
• PRESS CENTER
• https://www.imf.org/en/home