The World’s financial system would have collapsed in 2008 and early 2009 if the governments of the day (including their central banks) had have maintained the dominant belief held by most mainstream economists that fiscal policy is not capable of an effective stimulus to real economic activity and that building central bank reserves to historically massive levels would cause accelerating inflation. Within a short time, all that orthodox posturing that had been shared by politicians, their advisors, and the mainstream financial and economics media was abandoned and pragmatism reigned supreme. Well sort of! The system was saved because governments largely ignored the dominant mainstream economics view. At the time, I thought that this shift in policy practice was the beginning of a paradigm shift in macroeconomics. The crisis clearly demonstrated the poverty of the orthodox theoretical framework and the policy prescriptions that flowed from it. The dominant theoretical models didn’t even have banking sectors included such was the arrogant ignorance of the profession. However, I was wrong or perhaps a bit hasty in thinking that the defences built up by the orthodox economics Groupthink would fall so quickly in the face of this amazing failure. There was a period of quietness within the profession, save for the manic interventions of some of the more extreme Monetarist elements who called on the governments to do nothing other than continue deregulation and target even bigger fiscal surpluses. But the conservative voices progressively gathered volume as the crisis moved from the probability of collapse to a deep (balance-sheet) recession and the attacks on the fiscal and monetary policy shift that occurred in 2008 and 2009 began to reach fever pitch. Governments retreated somewhat and the recoveries were then stalled and we are where we are now as a consequence – still bearing the residual damage of the GFC with many of the trigger points still unresolved and facing a new calamity. Maybe the paradigm shift is still coming. Let’s hope so.
A recurring new theme I have noticed in the public debate recently is that commentators are discussing the rising probability of a renewed financial and economic crisis in the context of their claim that governments have run out of policy tools to combat such a calamity, should it occur.
The claim is that monetary policy has exhausted its options and that fiscal policy must remain in an austerity bias because of the public debt build up that accompanied the stimulus interventions and the automatic stabiliser effects in 2008-09.
The IMF keeps lecturing us about the lack of ‘fiscal space’ which might apply to a Eurozone nation which is in a straitjacket of austerity – the space being defined by the arbitrary fiscal rules, which bear no relation to reality or legitimate public purpose.
But at the same time they claim there is limited ‘fiscal space’ there remain millions of workers unemployed and underemployed as a result of deficient aggregate spending in economies all around the Globe. The reality is obvious. There is massive fiscal space, which can only be defined in terms of the availability of idle real productive resources that are for sale in the currency of issue.
The obsession with the primacy of monetary policy remains, a legacy of the Monetarist myth that fiscal policy could only cause inflation if governments tried to reduce unemployment below the ‘natural’ rate. The corollary was that monetary policy should target inflation and with that stabilised economic growth and prosperity would be maximised.
That wasn’t the original Monetarist position espoused by Milton Friedman and his cronies. They were more extreme and believed that inflation would be controlled if macroeconomic policy concentrated on targetting the growth in the money supply.
So if potential GDP growth was say 3 per cent per annum and the desired, stable inflation rate was 2 per cent per annum, then the central bank had to maintain a 5 per cent money supply growth rate. This simple formula just comes out of national accounts where real GDP growth plus the price level inflation gives nominal GDP growth rate.
Those outside the Groupthink knew it would fail as soon as they tried but central bankers fell for the Chicago line and in the early 1980s set about ‘monetary targetting’. It surely failed – dramatically in some cases.
The central bankers soon got their heads out of the mainstream textbooks which had told them, wrongly, that central banks could control the money supply via the interaction between base money (reserves and currency) and the mythical money multiplier.
They learned that the central bank is unable to control the growth in the money supply, which is, in fact, generated by demand for credit by the non-government sector.
The next fad was inflation targetting – much trumpeted but largely benign in itself. The evidence does not support the argument that nations that adopted formal inflation targetting experienced lower or more stable inflation rates relative to those nations that did not.
Please read my blog – Inflation targeting spells bad fiscal policy – for more discussion on this point.
But the monetary policy obsession remains.
There was an article I read on the flight back from Europe yesterday that said that the US central banker is now considering “deploying negative interest rates to combat the next serious recession even though they rejected that option during the darkest days of the financial crisis in 2009 and 2010.”
The article (October 10, 2015) – Fed officials seem ready to deploy negative rates in next crisis – is representative of the sort of ‘clutching-at-straws’ proposals that those who can’t see the elephant in the room are engaging in at present. A poverty of ideas really.
This proposal would have investors paying the central bank to keep their money safe.
The article says that negative interest rates were not introduced during the Great Recession in the US because the US Federal Reserve was worried that money management funds would not have been “able to recover management fees”, as an example of one of the issues rehearsed at the time.
The proposal would see banks ripping off depositors after a time elapse – so that “$100 in the bank would be worth only $98 after a certain period”.
The claim by the proponents is that:
With negative rates, “aggregate demand is no longer scarce”
If you believe that you will believe anything really. Deposits earn nothing anyway in most cases. So there would be innovations in the financial system if such a rip-off was introduced such that depositors would find alternative places to store their liquid wealth.
They hold cash balances for a reason – and it doesn’t include spending!
And, further, if aggregate demand (spending) is the problem that we want to tackle – and it is – then there are much more direct and effective ways to tackle a shortfall in spending than perverse machinations of the banking system and interest rate structure, which is largely ineffective in that context.
Its call FISCAL POLICY STUPID!
In his UK Guardian article (October 11, 2015) – The golden age of central banks is at an end – is it time for tax and spend? – Economics correspondent Larry Elliott traverses this topic.
Reflecting the mania that monetary policy is running out of options and so the world is heading into a major crisis about which we cannot defend ourselves, Elliot says:
The world is one recession away from a period of stagnation and prolonged deflation in which the challenge would be to avoid a re-run of the Great Depression of the 1930s. That fate was avoided in 2008-09 by strong and co-ordinated policy action: deep cuts in interest rates, printing money, tax cuts, higher public spending, wage subsidies and selective support for strategically important industries. But what would policymakers do in the event of a fresh crisis?
You get the drift – we are running out of options. What worked in 2008-09 is not available any more!
He questions whether policy makers would “double down on measures that have already been found wanting or go for something more radical?”
This question, of course, begs the question.
Who said that the measures employed in 2008-09 were “found wanting”?
It was clear and remains so that the central banks ensured the banks they wanted to protect were protected and the ones that were nationalised or allowed to go broke did not bring the system down.
There were complications in the Eurozone for example with some Member States having to incorporate the massive bailouts into their fiscal balances which then breached the ridiculous Stability and Growth Pact (SGP) rules and led to the austerity. But that is just a statement of how dysfunctional the design of the Eurozone is.
But more importantly, the fiscal interventions in 2008 and 2009 were very effective. There was a rebound in economic growth, household saving ratios rose and provided room for private debt to be reduced and balance sheets stabilised back into less precarious states, employment growth resumed and consumer sentiment improved.
It was hoped that policy makers were acting more than just pragmatically and had recognised that the recession was a particular type of downturn which we call a balance sheet recession, where the source of the instability comes not from the real economy but from the financial imbalances.
These recessions arise from the buildup of excessive private debt which eventually becomes so precarious that households and firms start to cut their spending in an attempt to produce savings that can allow them to bring the debt back down to less risky levels.
The remedy for that type of event is very clear – fiscal deficits have to be elevated for sustained and lengthy periods – perhaps more than a decade – while the non-government sector builds up its savings and runs down the excessive debt that triggered the crisis.
The problem was not that fiscal policy was “found wanting” but that the governments didn’t allow it to work properly, so intimidated were they by the neo-liberal economists who predicted doom and pestilence if they didn’t immediately set about reducing the inflated deficits.
One of the leaders of this mindless squawk squad was the IMF. They produced several ridiculous reports (of varying kinds) claiming that governments had to introduce “growth-friendly austerity” or face running out of money via a bond market rebellion.
“Growth-friendly austerity” is just their code for cutting net government spending and attacking the wages and conditions of workers and cutting pensions and other public services. Greece is their master plan!
Of course, there is no such thing as ‘growth-friendly austerity’. The IMF had the humiliating task of issuing successive updates to their forecasts which progressively downgraded their overly optimistic forecasts.
There was no accident here or slight imprecision. The IMF forecasts are biased to supporting their ideological position so it was obvious they would pump out unbelievable real GDP growth and low unemployment rate forecasts because they supported their claim that austerity would be good.
It was the sort of stuff you wouldn’t believe unless it actually happened.
As I have noted previously, even the IMFs own external evaluation body castigated them for being trapped in Groupthink, which used economic models that were prone to failure and made the institution unwilling to seek a diversity of viewpoints.
They haven’t really changed. Now, after several ridiculously optimistic growth forecasts, which have been similarly downgraded over the last few years, the IMF is lecturing governments and central banks on the possibility of crisis re-emerging.
That probability has been staring us in the face since the fiscal expansions in 2008 and 2009 were prematurely cut short in their tracks – since the Eurozone policy zealots started sabotaging the prosperity of the Member State economies.
The IMF growth forecasts since then have always been unbelievable and ideologically transparent. The fact that anyone takes them seriously is a testament to how deeply entwined we have become in the neo-liberal fantasy world.
Larry Elliot thinks the alternative to these “found wanting” policies would be “something more radical”! He is talking here about monetary policy innovations such as the negative rates I noted above.
But there is nothing radical about a willingness of the government to allow their fiscal deficits to expand. That is basic policy. It reflects the basic macroeconomic rule that SPENDING = INCOME = OUTPUT which then drives employment.
Elliot quotes Larry Summers who “says the answer is to accept that fiscal policy – taxes and public spending – have a bigger role to play.”
That was always the answer! Despite all the Monetarist myths, the most effective aggregate policy tool available to governments that are intent on influencing aggregate spending in the economy is fiscal policy – spending and taxation.
As I wrote in this blog – There is no financial crisis so deep that cannot be dealt with by public spending – still! – fiscal policy really matters.
Perhaps my sense that there is a paradigm shift in the offing might turn out to be valid. Perhaps we are just being impatient. Perhaps it needed a second major downturn or the threat of it to push the debate away from a reliance on monetary policy.
It sure takes a long time for people to wake up to the obvious though.
The not-the-Nobel prize in economics
The UK Guardian article (October 11, 2015) – Economist Sir Richard Blundell among Nobel prize frontrunners – presents a form guide for the likely recipients of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, which economists think is equivalent to a Nobel Prize from the Nobel Foundation, set up by the will of Alfred Nobel.
The ‘johnny-come-lately’ economics prize was unrelated to these grand awards and only began in 1969 after the Swedish central bank (Sveriges Riksbank) injected some money (as any currency-issuing government can) to set up the prize.
One manifestation of Groupthink among dysfunctional groups is that they establish awards and prizes to give to each other as a way of legitimising their status and demonstrating to the outside world that this status is to be respected and taken seriously.
The public don’t really know what the award is for – but they have been conditioned to believe that a Nobel Prize is big and attach gravitas to it. The public certainly are mostly ignorant of the fact that the Economics prize is not a real Nobel Prize but a title that the dominant group within the profession itself gives to one of its own.
A pat on the back type award for playing along with the group paradigm.
Please read my blog – Nobel prize – hardly noble – for more discussion on these points.
Given the majority of the recipients ever since, the ‘award’ disgraces the original concept of the Nobel Prize that the Foundation delivers each year.
The Guardian’s ‘form guide’ includes Rogoff and Reinhardt, and ‘Mr Iceland Financial Stability’, Frederick Mishkin among other possible winners, which demonstrates the farcicial nature of this ‘award’.
But then we already knew how low the awarding body could stoop when they handed it out to ‘Mr Efficiency Markets’ Eugene Fama in 2013, after the real world had categorically shown that unregulated financial markets are anything but efficient.
In the last few days, a senior member of the Royal Swedish Academy of Sciences, Bo Rothstein, who is also Professor of Political Science at the University of Gothenburg and Oxford University, has rehearsed similar concern about the tainted link between the award from the Nobel Foundation and the Economics Prize.
In an Op Ed article in Sweden’s largest circulating newspaper, Nyheter (October 11, 2015) – ”Ekonomipriset i strid med andan i Nobels testamente” – Bo Rothstein argued that the study of economics seemed to promote a proneness to corruption in professional life, which was “in conflict with the spirit of Nobel’s will” (translation from the Swedish).
Rothstein’s concerns are that corruption is endemic in developing and developed nations and impacts on “every measure of human welfare” such as “infant mortality, economic prosperity, life expectancy, the number of children living in poverty, access to clean water, the number of women who die in childbirth, willingness to fix environmental problems and more.”
He said that research has demonstrated that “financial market collapse in 2008 can be explained in terms of corruption”.
What are the causes of this corruption? He argued that while most societies clearly do not “internalise this behaviour” – that is, they “realise that corrupt is damaging for their communities”, they go along with it as a pragmatic response because “they do not perceive that they have any real choice” but to engage in corruption.
He uses the example of paying medical professionals extra money “under the table to get medical care for their children”. We get situation where “if one believes that the ‘everyone else’ is involved in this shady business” then most people will “either join in or you see it as futile to resist”.
He says that the common folk adopt this viewpoint because the political and economic elites are corrupt and “if they are known to engage in all sorts of irregularities” then this “spreads quickly down into the community”.
He notes the German proverb – “the fish rots from the head down” – to describe what he is thinking about.
The next step in his argument is that:
… there are interesting differences when one examines the perceptions of these ethical problems that the different university programs generate. Multiple independent research shows that those who study economics are more prone to corruption than those studying other subjects. This first appeared in a number of so-called experimental studies that put the students in various hypothetical situations. These have recently been supplemented by a study done on real data by René Ruske (published in the journal Kyklos 2015) of members of the US Congress. His study shows that those members who have a degree in economics has had twice the risk of having been involved in corruption compared to those without this training. The reason for these results seems to be that there is an ideological element in business studies that emphasise the importance of selfish behavior – the notion of a so-called “homo economicus”. The experimental research additionally shows that this dysfunctional behavior is not just something the students bring to the program, but it is often an effect of what they learn.
This research is also allied to the studies that show that studying economics breeds sociopaths.
The problem is that economics training provides a path “to high positions in society”.
While others (such as myself) have argued that the Nobel Prize in Economics is a farce given the appalling performance of economic theory in relating to the real world, Rothstein is less interested in that argument and considers it “incorrect”.
His concern is that “university education in economics” seems to lead to an “increased tolerance to corruption” and is thus in “direct contravention of Alfred Nobel’s will, which stipulated that prices would be awarded to ‘those who, during the preceding year, shall have the greatest benefit on mankind'”
That is enough for today!
(c) Copyright 2015 William Mitchell. All Rights Reserved.