November 25, 2014 6:17 pm
Radical cures for unusual economic ills
The crisis left a grim legacy, and the answers are likely to be unorthodox
Yet there are even more disturbing possibilities than debt overhangs. In my book, The Shifts and the Shocks, I suggest that a number of shifts in the world economy created chronically weak demand in the absence of credit booms. Among these were excess savings in emerging economies and shifts in income distribution, ageing and a secular decline in the propensity to invest in high-income countries.
Behind these shifts lay, among other things, globalisation, technological innovation and the growing role of the financial sector. It is not enough to clean up after the debt boom has collapsed. Policy makers also have to eliminate the dependence of demand on unsustainable credit.
Without that, even a radical clean-up will not deliver buoyant demand. True, if a country is small, it may be able to import the missing demand via the external account. But when huge parts of the world economy are afflicted, alternative solutions are needed. There are three broad alternatives: live with chronic demand weakness; run aggressive demand policies indefinitely (as Japan has done); or fix underlying structural demand weaknesses.
Hyper-aggressive monetary policy helps by delivering real interest rates that are well below zero. An alternative is fiscal deficits. But that risks putting debt on a permanently rising path.
Still more unorthodox is outright monetary financing of fiscal deficits, as Adair Turner, former chairman of the UK’s Financial Services Authority, has recommended. This means nationalising the creation of money now delegated to often-irresponsible private banks. This is a more direct (and probably more effective) way of using a central bank’s power to create money in order to expand demand than employing it indirectly, via manipulation of asset prices. Such direct monetisation of deficits seems particularly sensible in Japan.