In a recent article in the Financial Times, Mohamed El-Erian observes that: “Central bankers now operate in a world where monetary policy influences only a small part of the fluctuations in overall liquidity in the economy. Endogenous liquidity, or the extent to which the market itself expands and contracts liquidity, has taken over as the main driver.” 13 This may well be so but it is far from obvious why abundant liquidity, which is necessarily short-term, and low short-term interest rates should keep long-term rates very low over protracted periods of time. There might have been elements of both a saving glut and a liquidity glut in recent years. It seems fair to conclude, however, that in the global economy there is limited scope for the individual central bank to influence long-term real interest rates. In a Wicksellian sense this might be awkward. In a way we can argue that the root cause of these challenges to monetary policy is the global macroeconomic imbalances. While improved monetary policy and the globalisation process have contributed to lower inflation and lower output volatility, asset price and exchange rate volatility seem to have been unaffected. 14 In fact, some argue that with a credible nominal anchor and stable inflation expectations, low interest rates and hence higher liquidity first and foremost translate into higher asset prices – not higher inflation as measured in the conventional way. 15 Rapidly rising property prices and debt over long periods can be a source of future instability in the real economy.
As shown in Chart 3, 2008 stands out as one of the worst years in this period. Ten years ago, on 25 November 2008, Norges Bank presented the GPFG’s results for the third quarter. Lehman Brothers had gone bankrupt. The world’s central banks were making large and frequent cuts in policy rates. In the course of autumn 2008, the US stock exchange fell more than five percent on as many as ten separate days. Norges Bank wrote in its press release that “The third quarter of 2008 was an unusually demanding quarter for the management of the Government Pension Fund – Global.” And it was to get worse. The GPFG posted a return for 2008 of minus 23 percent, measured in terms of the fund’s currency basket. Chart 4: Post-crisis paths have differed Chart 4 shows developments in the US equity market from 2008 onwards. The rapid reversal in equity markets, shown in the chart, also affected the GPFG’s results. In 2009, the fund posted a positive return of 26 percent, largely thanks to a 34 percent return on the equity portfolio. The return continued to rise in 2010. While the fall in the fund’s value as a result of the financial crisis in 2008 was historically large, the fund’s recovery in 2009 was stronger and faster than had generally been expected. Owing to a weakened krone, the GPFG’s return was less negative in terms of NOK than in terms of the fund’s currency basket.