Collective Household Economics: a Wake Up Call for Central Banks?

In section 1 of this paper, the main policy objectives of four of the world’s most important central banks: the Federal Reserve of the U.S., the European Central Bank, the Bank of England and the Bank of Japan have been summarized. Warranting a closer look is not so much what these policy objectives are and the ground that they cover but, notwithstanding how important they may be, what is left out. After the financial crisis of 2007-2008, central banks have moved decisively towards strengthening the banking sector with the aim of improving the shock absorption capacity readying banks for any future heavy loan losses. ‘Too big to fail’ risks have been addressed. Other sectors of the financial services arena like insurance companies, pension funds and asset management companies, have also become the subject of intense regulatory scrutiny. More needs to be done, but major steps have been taken. Central banks have also provided US$7 trillion of monetary stimulus and kept their lending rates at near zero. The ECB and the Bank of Japan are still in the process of buying government and other types of debt paper, all with the aim of stimulating economic growth. As of August 2015, inflation levels stood at 0.2% in Japan and 0.2% in the Euro Area, -0.1% in the U.K. in September and -0.2% in the U.S. for August. These levels are far below the target level of inflation, which has been set at or slightly above 2% at on annual basis. All this has not prevented the IMF from predicting a slide towards the next global recession. A US$3 trillion company debt burden, especially in emerging markets, may come to haunt the broader financial markets. Have central banks run out of options to stimulate growth? Are their tools still fit for purpose? Should one continue with yet more quantitative easing and/or negative interest rates? Or is perhaps the use of a ‘one-size fits all’ base rate for stimulating households, companies and a government no longer the right approach to managing an economy? Should the borrowing behavior of individual households be treated differently from those of companies? After all individual households do not operate on a for-profit basis. In a paper by this author: “Collective Household Economics and the need for funds approach; the 2007-2008 financial crisis and its effects” it was argued that the demand for long term funds borrowed by individual households (mainly mortgages) was not based on the same parameters as the supply of funds by the banking sector. The demand (or need) for funds was based on population growth, changes in average household size and changes in taste patterns; all non-financial matters. It was also based on affordability levels to service mortgage debt out of incomes. The paper concludes that households need a ‘dynamic stability’ in their long-term debt obligations. This could be achieved with the help of different central bank tools strictly for the benefit of individual households. Such tools could include a volume mortgage lending control mechanism: a traffic light system directed to the lenders side. Another tool could be a dual price setting mechanism for households’ long-term debt. Households would pay for the debt on the basis of CPI level plus a margin, while lenders would receive costs of funds plus their margin. Of course, as the paper showed, differences between these rates will occur, the fix for which could be to use funds backed by the Treasury in some years to bridge the gap. In other years, Treasury will benefit from such differences. Finally, enhanced quality control measures will mean that mortgages are long-term borrowings with full repayments. Creating such an environment will allow central banks to move their base rates more freely and in line with the level of corporate activities. The notion that households, companies and a government all need the same base rate level has proven to be unworkable. The more stable the financial position of individual households, the better the growth prospects for the whole economy.