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La crisi va peggio, la politica può fare meglio
How to make the best of the long malaise
The only good thing about the continuing barrage of bad economic news is that it could have been worse: all three rating agencies could have downgraded the US, stock markets could have fallen further and the US could have defaulted on its debt. The general view is now that in this, the next round of the Great Recession, there is a high risk of things getting worse, with no effective instruments at governments’ disposal. The first point is correct but the second is not quite right.
Throughout the crisis – and before it – Keynesian economists provided a coherent interpretation of events. Pre-crisis, America, and to a large extent the world economy, was sustained by a bubble. The breaking of the bubble has left a legacy of excess leverage and real estate. Consumption will therefore remain weak and austerity on both sides of the Atlantic now ensures the state will not fill the void. Given this, it is not surprising that companies are unwilling to invest – even those that can get access to capital.
Of course, those worried about the shortage of policy instruments are partially correct. Bad monetary policy got us into this mess but it cannot get us out. Even if the inflation hawks at the Federal Reserve can be subdued, a third bout of quantitative easing will be even less effective than QE2. Even that probably did more to contribute to bubbles in emerging markets, while not leading to much additional lending or investment at home.
The Fed’s announcement that it will keep the target federal funds rate near zero for the next two years does convey its sense of despair about the economy’s plight. But, even if it succeeds in stopping, at least temporarily, the slide in equity prices, it will not provide the basis of recovery: it is not high interest rates that have been keeping the economy down. Corporations are awash with cash, but the banks have not been lending to the small and medium-sized enterprises that are, in any economy, the source of job creation. The Fed and Treasury have failed miserably in getting this lending restarted – this would do more to rekindle growth than extending low interest rates though 2015!
But the real answer, at least for countries such as the US that can borrow at low rates, is simple: use the money to make high-return investments. This will both promote growth and generate tax revenues, lowering debt to gross domestic product ratios in the medium term and increasing debt sustainability. Even given the same budget situation, restructuring spending and taxes towards growth – by lowering payroll taxes, increasing taxes on the rich, as well as lowering taxes for corporations that invest and raising them on those that do not – can improve debt sustainability.
The politics, however, are elsewhere. Markets know that the mix of low tax and debt fetishism sweeping the North Atlantic means that there are no instruments at hand: monetary policy won’t work, fiscal policy is constrained, growth will slow and the improvement in deficits (brought by austerity) will be disappointing.
But markets have a political agenda too, clearly evident in S&P’s downgrade. No economist would look just at the debt side of a balance sheet, yet that is what S&P focuses on. Even more telling is the fact that the US pays its debts in dollars, and it controls the printing presses. There is thus no chance of a default – apart from the kind of political charade we saw last week.
Markets are often wrong but the rating firms’ record does not inspire confidence – certainly not to justify replacing the aggregate views of millions with judgments of a few “technicians” working in a firm whose governance and incentives are problematic. Europe’s leaders were right in their recent meeting to call for less reliance on these ratings.
Europe and America now face extraordinarily difficult politics. It is hard to know which is worse: America’s gridlock, or Europe’s broken political structure. Europe’s leaders have taken decisive action but events move faster than their processes of ratification and implementation. Europe’s debt-to-GDP ratio is also lower than in the US; if it had an adequate common fiscal framework, it would be in a better position than America, too.
Europe’s other problem is too many think fiscal stringency is now the answer. Yet Ireland and Spain had a surplus and low debt-to-GDP ratios before the crisis. More austerity will only ensure that Europe grows more slowly and its fiscal problems will mount. Only latterly have Europe’s leaders finally recognised that Greece and the other crisis-plagued countries needed growth – and that austerity would also never bring that growth.
All of this makes it more likely that the North Atlantic will enter a double dip, but there is also nothing magic about the number zero. The critical growth rate is that which stops the jobs deficit growing larger. Problematically, America and Europe’s current growth rate of about one per cent is less than half of the amount required to do this.
When the recession began there were many wise words about having learnt the lessons of both the Great Depression and Japan’s long malaise. Now we know we didn’t learn a thing. Our stimulus was too weak, too short and not well designed. The banks weren’t forced to return to lending. Our leaders tried papering over the economy’s weaknesses – perhaps out of fear that if we were honest about them, already fragile confidence would erode. But that was a gamble we have now lost. Now the scale of the problem is apparent, a new confidence has emerged: confidence that matters will get worse, whatever action we take. A long malaise now seems like the optimistic scenario.
* The writer is a recipient of the 2001 Nobel Prize in economics and professor at Columbia University .Copyright The Financial Times Limited 2011.