Broken Systems Equals Lame Recovery
Five years after the financial meltdown, the global economic recovery is hardly worthy of the name. The International Monetary Fund has just revised its forecasts for the world economy down — again.
Growth almost everywhere could and should be faster. What’s holding it back? The list of causes is long, and the details vary from place to place, but toward the top is a kind of self- willed institutional incapacity.
In itself, a slow recovery isn’t surprising. Recessions involving financial crashes are harder to shrug off than ordinary downturns. Even so. For 2013, the IMF predicts growth of 1.2 percent in the advanced economies. The United States is expected to see output growth of 1.7 percent, which is feeble; output in the euro area is projected to fall by 0.6 percent, which is outrageous. Prospects have worsened in the emerging economies, too. They’re told to expect another year of growth at 5 percent — by their standards, much too slow.
When we look back on this calamity, we’ll see two great failures of coordination, neither of them much emphasized in real-time economic commentary. First, a strong response to a global slowdown demands effective international cooperation. After a promising start in 2009, there has been precious little. Second, at the national level, so deep a recession — one that pulls interest rates to zero and requires unusual kinds of stimulus — demands careful co-management of different strands of policy. That’s something governments have been unable or unwilling to do.
These are very different issues, but they have something crucial in common: They’ve tested the world’s economic-policy institutions and found them wanting.
The failure of international cooperation is most egregious in the European Union. The EU did more than just miss opportunities to bolster confidence and investment, a global failing. European policy has actively militated against recovery. On a point of principle, the EU core inflicted severe fiscal contraction on the periphery. On a point of principle, the European Central Bank has let the goal of EU-wide low inflation deflect it from providing monetary stimulus adequate to the needs of countries where demand has collapsed.
Economic policy in a single currency area has to meet special demands. The euro required far-reaching institutional redesign. That has yet to happen. For instance, a genuine banking union is a sine qua non for this enterprise; even though EU leaders have finally acknowledged the issue, they have made scant progress. You could be forgiven for thinking that the European Union was the victim not of a failure of cooperation but of a successful conspiracy to destroy itself.
Globally, the story is more one of chances missed. Governments should have given the IMF more resources sooner, for instance, to better help distressed sovereign borrowers. Governments should have amazed businesses worldwide by reviving the Doha Round of global trade talks, upping their ambitions on trade liberalization and bringing that project to an urgent and successful finish. Instead they let it shrivel. So far a collapse into trade war has been averted — that’s something, I suppose — but there’s been serious backsliding, and the chance for some much-needed shock and awe on trade reform went begging.
The institutions of economic policy have also failed at the national level. Settled doctrine before the crash of 2008 called for keeping fiscal policy, monetary policy and financial regulation in separate silos. This division rested in part on a view about central banking that worked fine in good and moderately bad times, but fails in a situation like this. Central banks, according to this view, could be set to the simple task of keeping inflation low, and be shielded from politics in discharging it.
Post-crash macroeconomic policy recognizes that the lines between fiscal, monetary and regulatory policies aren’t so clear. For maximum stimulus effect, all three have to work in harness.
Consider the case of outright monetary financing of government spending — or “helicopter money,” as it’s sometimes called. This is fiscal policy: The government sends everybody a check. It’s also monetary policy: The central bank finances the outlay by buying and indefinitely retaining government debt. And it implicates regulatory policy, because it changes the cost of capital across different asset classes.
Quantitative easing isn’t quite helicopter money (because the central bank expects to reverse its debt purchases at some point) but the basic criticism applies. Because it isn’t the purely apolitical intervention that advocates of central-bank independence had in mind, central banks are inhibited in its use. (In Europe, this inhibition is enshrined in law.) The limits imposed by independence also complicate the forward guidance the Fed and other central banks have adopted or are about to adopt. For example, in setting thresholds for unemployment and schedules for getting it down, they’re straying onto political terrain, so they have to be circumspect. Deliberate vagueness muddies the message, adding to the confusion that has lately roiled financial markets.
Fears that aggressive QE might cause financial instability when it’s reversed raise a related point. These concerns should be taken seriously, even if signs of a risky “reaching for yield” are few right now. In principle, though, the answer is not to keep QE below the level indicated by the shortfall in aggregate demand; it’s to adopt financial rules that promote safety in times of financial stress (above all by requiring financial intermediaries to be better capitalized). The IMF’s new report makes this point in passing, but without setting it in the bigger picture.
Clive Crook is a Bloomberg View columnist.