Saturday, 7 April 2012

It is time to end the era of policy extremism

Britain is now in its fifth year of economic stagnation. Since the Northern Rock failure, and the beginning of the financial crisis, there has been the occasional quarter of positive growth, but the uptick have been invariably followed by disappointing quarters of flat or even negative growth. UK GDP is still about 4 percent lower than it was at the end of 2007.

This recession is unique. Over the last century, the UK has suffered periodic downturns, typically about once a decade. But there was always the robust upswing, usually within two years of the initial crash. But something is different this time. The economy seems stuck and unable to recover.

We are by no means alone in experiencing this strange era of stagnation. Growth has disappeared throughout Europe. Across the Atlantic, the US economy is doing little better. This week's US employment numbers were extremely disappointing. For the last two decades, Japan has been trapped in the dead pool of near zero growth.

Nevertheless, one shouldn't think that stagnation is a global event. Asia, Latin America, and even Africa are all enjoying robust growth. The global crisis is really a problem for advanced economies. The rest of the world, more or less, is doing just fine.

There is a second perhaps more important distinction between emerging and advanced economies. The emerging economies are playing a very straight game in terms of macroeconomic policy management. In Europe and North America, governments and central banks are pursuing what is become euphemistically described as an unorthodox policy measures. Central banks have pushed policy rates close to zero. They are also pumping out huge quantities of cash, primarily into the balance sheets of stricken banks. Ministries of finance are borrowing huge amounts of money to finance historically unprecedented gaps between tax revenues and expenditures.

The justification for these extremist policies is that they prevented an apocalyptic meltdown. Central bankers and finance ministers tell us that without negative interest rates and double-digit deficits economies in advanced countries would have collapsed. A desperate time needed desperate measures.

With each passing quarter, this hypothetical apocalypse grows larger. An obvious lesson might be that quantitative easing,and rapidly accelerating debts might not be the right strategy for sustained economic growth.

That is a very uncomfortable conclusion. There are far too many politicians and central bankers who are now deeply compromised by these policies. To reverse the strategy and return to more sensible monetary and fiscal policies would be to admit that the policy extremism the last four years was a dreadful and unforgivable mistake. Therefore, there are strong incentives to exaggerate the magnitude of the 2007-8 crisis.

Nevertheless, the question remains how do we get out of this policy quagmire. Everyone understands that at some point interest rates will have to rise and that deficits will have to fall. However, everyone understood this back in 2008 and when interest rates were slashed and deficits ramped up. Everybody also thought that by 2012 everything will be back to normal. Yet here we are. Growth is still basically zero, and the macroeconomic policy framework is a total mess.

Where will we be in another four years? Will the BoE still be operating their quantitative easing scam, along with negative real interest rates? Will the government continue to run up massive deficits? Personally, I don't think so. Things have to change. If nothing else, debt levels cannot continue to grow much beyond their current level. This is what southern Europe discovered over the last two years. Sooner or later, bondholders say no and walk away. Eventually, creating money to fund deficits leads to uncontrollable inflation.

There are limits to policy extremism.


Jo said...

Come the reset, all the bad actors will swing.

Jim said...

The only bits of the world that are growing are the ones that either have no debt, or low levels of it. Countries that either dig stuff out of the ground, grow stuff, or make stuff that other countries want, and will pay for. What a surprise.

The West has been pulling forward its consumption from the future (via debt) for decades (about 1975 in the UK's case). A nation can do that for a long time, I think we have now reached the end of that road.

The only way growth of any significance could be resumed in the UK is if we somehow managed/wanted to increase our debt levels. There's no intrinsic wealth creation here that can drive growth.

Stevie b. said...

"Eventually {whenever that may be}, creating money to fund deficits leads to {relatively uncontrollable} inflation"

So dosh will go down and the right "stuff" will go up to compensate. If you're a pensioner on a relatively fixed income with some savings, I'd guess you'd need more of those savings to be in the right "stuff".
If you're young you need to be in a job with some sort of inflation protection via scarcity or commission - either that or emigrate..

old man said...

Currently we have too much personal debt and can't / won't borrow more so can't spend.
Maybe the way forward is to reduce personal and business debt by 'helicopter' say 10k per person off their mortgage/credit card or as a bung into their bank. Sod the bank shareholders tough they lost. Also put some money into good business to reduce their debt.

Then put interest rates to about 5 percent and watch normality return.

Anonymous said...

Old man - great idea except QE is about protecting rich banker, and we ain't one of them.