Break away from obsolete monetary policy instruments (Orthodox school of thought)

By Shahab Sabahi – Energy and Environment for Development – Research Group

 Since July 2007 and particularly June 2011 onwards, the stock market in the US is undervalued. Stock’s prices are lower than the estimate of their fair value. It raises the questions “why the investors’ expectations are so low while real yields are negative” and “why the decrease in interest rates have not produce the increase in investments expected by the central bank”.

It can be argued around investments decisions behaviors. They are based on cost of capital of which interest rates are just one part. The other part, the cost of equity is so high that it takes promising exceptional high rate of return on capital to invest. In a world with uncertainty and complexity as the dominants factors, these investments are difficult to find. It is quite different from a probabilistic environment. In a probabilistic environment businesses can simulate business models with the increasing supply of data. However in the presence of complex systems where, interdependence, connectedness, diversity, and adaptation/learning rule, additional data does not help. In such an environment, businesses find hard, even with data analysis, to distinguish the market signal from the noise. We now face a complex world rather than a complicated one. A complex system stands between order and chaos. A complex system produces non-periodic patterns and emergent structures and functionalities. We should not expect a reduction in the cost of capital under the existing regulatory systems. Even if the real interest rates continue to decrease, businesses should overcome the uncertainty and the complexity of new investments. It is the real cost of capital in the present competitive environment.

Demand for higher cost of equity will promote the notion of rent seeking and short termism.  The world will encounter poor quality and high risky investments. Unfortunately our regulatory systems are still practicing traditional monetary policy. The regulatory systems have not come up with new innovative instruments and not prepared for addressing our today’s real challenges.