We are in a slump, the longest slump in modern economic history. GDP is still 4% below its pre-crisis level, we have over 2.6mn people out of work and another 2mn under-employed. Real wages have are falling and we’re experiencing the biggest crisis in living standards in generations.
The government has no plan to deal with this. Austerity is failing even on its own terms. Households are over-indebted and are experiencing falling income, export prospects look bleak and firms, understandably, are reluctant to invest.
To end this slump will take a fiscal stimulus, the one thing the government has set its face against.
Of course the slump won’t last forever, eventually we’ll experience some sort of weak growth. But we are now in the situation of Japan in the 1990s, of which Paul Krugman has written:
The slowness with which Japan’s economy deteriorated was in itself a source of much confusion. Because the depression crept up on the country, there was never a moment at which the public clamoured for the government to do something dramatic. Because Japan’s economic engine gradually lost power rather than coming to a screeching halt, the government itself consistently defined success down, regarding the economy’s continuing growth as a vindication of its policies even though that growth was well short of what could and should have been achieved. And at the same time, both Japanese and foreign analysts tended to assume that because the economy grew so slowly for so long, it couldn’t grow any faster. (My emphasis)
Jonathan Portes thinks the government have started to recognise this via recent plans to guarantee private investment:
No doubt the Treasury will find a way of ensuring that whatever guarantees are offered have no direct, short-term impact on the measured fiscal aggregates. But from an economic point of view that is irrelevant. The economic difference between the government borrowing from the private sector to finance investment spending, and the government guaranteeing the borrrowing of another entity – with the government guarantee meaning that the lender has no more or less risk of non-repayment than if the money was lent direct to government – is marginal.
So the government has now conceded the intellectual and economic argument.
I’m less hopeful – we’ve heard this sort of talk before, for example this speech from Nick Clegg in September last year.
The Bank of England, clearly concerned about the outlook, has restarted its quantitative easing programme. But, as I’ve argued in the past, fiscal and monetary stimuli are not close substitutes for each other.
And the longer this slump continues – the more long-term damage that will be done the economy and to people’s prospects.
Today Martin Wolf writes (behind the paywall) argues, correctly, that when the private sector is deleveraging and increasing its savings, the public sector has to spend.
As he writes, the private sectors of all the major advanced economies are now running private sector savings surpluses:
It follows that these countries must be running large current account surpluses or large fiscal deficits. Germany is doing the former. Others are running fiscal deficits. Since these big countries are unlikely to be able to run large current account surpluses together (with whom?), they have to run fiscal deficits once their private sectors run huge surpluses.
This isn’t some fancy economic theory, it’s a simple accounting identity.
German, US, Japanese and UK government bond yields (the interest rate on government debt) are at, or very near, historical lows.
As John Kemp wrote this week at Reuters we have a ‘bubble in fear’.
Arguably, many investors, businesses and households are exhibiting an irrational demand for liquidity and safety, and aversion to risk, based on a miscalculation about risks — refusing to accept even a small threat of being suddenly wiped out by default or recession, while accepting a large risk of being gradually wiped out by inflation and the bubble unwinding.
Investors are so scared of putting their money to work elsewhere that they would rather buy ‘safe’ government debt, even if that means negative real interest rates. As long as this is the case we won’t see the vital investment spend we need to drive a decent recovery.
Central banks, including the Bank of England, are attempting to deal with this problem through monetary expansion and QE:
…quantitative easing — which lowers the prospective returns on safe, liquid assets and is designed to punish savers and investors who insist on continuing to hold them rather than putting their money to work in more productive and riskier ways.
The implicit message from Fed Chairman Ben Bernanke and his colleagues around the world to investors is that the continuing preference for liquidity will come with a hefty price tag; it may insure against short-term default and adverse market movements, but it is guaranteed to lose money in the long term.
But, as Keynes recognised 80 odd years ago, monetary expansion alone will not be enough:
Keynes himself, though, was sceptical about whether monetary policy could overcome a bubble in fear and extreme demand for liquidity. It is why he argued that, in some circumstances, the government should step in to commission the investment that firms and households declined to commission themselves.
Because the government can spread risk across the whole of society, its capacity to accept negative outcomes on at least some projects, is far higher than for any single business or individual. It was the government’s superior capacity to bear risk — not any inherent belief in its capacity to make better decisions — that led Keynes to advocate greater state-led investment when the economy becomes gripped by a bubble of fear. (My emphasis)
This point was reiterated this week by Bruce Barlett in an article on the lessons of 1932.
In a May 1932 article in The Atlantic Monthly, John Maynard Keynes agreed that deflation was the core economic problem and that cheap money was the necessary cure. But he warned that the economy’s downward momentum may have gone too far for conventional monetary policies to work… Keynes warned that there might be “no means of escape from prolonged and perhaps interminable depression except by direct state intervention to promote and subsidize new investment.”
A fiscal stimulus wouldn’t be the end of our economic problems, we can’t just go back to the business as usual world of pre-2008, for the reasons Frances OGrady argues today – we need to build a ‘new economy’.
But the first priority of policy makers right now should be ending the slump. Monetary policy will play a part in that – but without fiscal stimulus this slump will be much longer than it has to be, and it’s ordinary people who will pay the price.