ZIRP: good, actually!

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It says a lot about many of the start-ups that investors have backed over the past decade that they make The Office’s WUPHF.com sound like a really good idea.

Juicero, Jawbone, MoviePass, Fyre Festival, Quibi, Vice, WeWork, Zume, Wag — almost the whole SoftBank oeuvre, really. It’s inevitable that the vast majority of start-ups fail, but the amount of venture capital a lot patently silly companies have incinerated in recent years is gobsmacking.

And those are just the start-ups. Zuckerberg has spent $36bn on developing a legless digital wasteland, while Apple has spent north of $22bn over the past year on . . . something, we hope. We’re not going to mention Amazon blowing $1bn on Rings of Power, because some of us actually quite liked it (ducks).

To a lot of people, all these things are just symptoms of one fundamental force that has warped everything in the world for the past decade: zero-interest rate policies. Why not chuck money at increasingly fantastically stupid things when money is basically free? Now that rates have climbed again, we can all behold the detritus left in the wake of ZIRP.

But maybe easy monetary policy and the bubbles it can stir still helps more than it hinders — at least if you focus on the macroeconomic forest rather than the shareholder trees?

From a new NBER working paper titled Monetary Policy and Innovation by Yueran Ma of the University of Chicago and Kaspar Zimmerman of the Frankfurt School of Finance:

We document that monetary policy has a substantial impact on innovation activities. After a tightening shock of 100 basis points, research and development (R&D) spending declines by about 1 to 3 percent and venture capital (VC) investment declines by about 25 percent in the following 1 to 3 years. Patenting in important technologies, as well as a patent-based aggregate innovation index, declines by up to 9 percent in the following 2 to 4 years. Based on previous estimates of the sensitivity of output to innovation activities, these magnitudes imply that output could be 1 percent lower after another 5 years. Monetary policy can influence innovation activities by changing aggregate demand and correspondingly the profitability of innovation, and by changing financial market conditions. Both channels appear relevant in the data. Our findings suggest that monetary policy may affect the productive capacity of the economy in the longer term, in addition to the well-recognized near-term effects on economic outcomes.

Basically, easier monetary policy tends to stimulate R&D bonanzas, stir VC splurges and nurture innovation, while tighter monetary policy does the reverse.

And all that innovation tends to enhance the productivity and potential of an economy (in addition to the more obvious near-term impact of lower interest rates). In other words: bubbles should be praised! The broader economic gains of easy monetary policy outweigh the wealth destruction suffered by investors that are sucked in.

This is not an entirely novel observation, of course. We’ve known for ages that easy monetary policy can inflate bubbles, and that while bubbles can destroy an immense amount of wealth when they burst, they still tend to leave behind something of real lasting value, even if it isn’t immediately clear what it is.

The canal and railway manias of the 1790s and 1840s respectively helped transform the UK into the world’s leading economy, for example. More recently, the dotcom bubble did help finance an immense amount of innovation and cable-laying that we still benefit from today (as well as Pets.com).

Perhaps once all the stupidity enabled by the ZIRP era has washed away, we’ll realise that something good came out of it? ¯_ (ツ)_/¯ (Suggestions welcome below)

Ma and Zimmerman stress that while their findings indicate that “monetary policy could have a persistent influence on the productive capacity of the economy, in addition to the well-recognized near-term effects on economic outcomes”, that doesn’t mean rates should be set permanently too low.

We do not think our findings necessarily imply that monetary policy should be more dovish. It is well recognized that efforts seeking to perennially stimulate the economy with monetary easing can be ineffective or counterproductive. In addition, as recent research points to the effects of monetary policy on a growing list of economic outcomes, it seems challenging for monetary policy alone to balance all these dimensions.

Which is true of course. But it still feels a little like they’re weaseling out of the clear implications of their research. Let it run hot!