The world economy
Out of ammo?
Central bankers are running down their arsenal. But other options exist to stimulate the economy
WORLD stockmarkets are in bear territory. Gold, a haven in times of turmoil, has had its best start to a year in more than three decades. The cost of insurance against bank default has surged. Talk of recession in America is rising, as is the implied probability that the Federal Reserve, which raised rates only in December, will be forced to take them back below zero.
One fear above all stalks the markets: that the rich world’s weapon against economic weakness no longer works. Ever since the crisis of 2007-08, the task of stimulating demand has fallen to central bankers. The apogee of their power came in 2012, when Mario Draghi, boss of the European Central Bank (ECB), said he would do “whatever it takes” to save the euro. Bond markets rallied and the sense of crisis receded.
But only temporarily. Despite central banks’ efforts, recoveries are still weak and inflation is low.
Faith in monetary policy is wavering. As often as they inspire confidence, central bankers sow fear.
Negative interest rates in Europe and Japan make investors worry about bank earnings, sending share prices lower. Quantitative easing (QE, the printing of money to buy bonds) has led to a build-up of emerging-market debt that is now threatening to unwind. For all the cheap money, the growth in bank credit has been dismal. Pay deals reflect expectations of endlessly low inflation, which favours that very outcome. Investors fret that the world economy is being drawn into another downturn, and that policymakers seeking to keep recession at bay have run out of ammunition.
The time has come for politicians to join the fight alongside central bankers. The most radical policy ideas fuse fiscal and monetary policy. One such option is to finance public spending (or tax cuts) directly by printing money—known as a “helicopter drop”. Unlike QE, a helicopter drop bypasses banks and financial markets, and puts freshly printed cash straight into people’s pockets. The sheer recklessness of this would, in theory, encourage people to spend the windfall, not save it. (A marked change in central banks’ inflation targets would also help.)
Another set of ideas seek to influence wage- and price-setting by using a government-mandated incomes policy to pull economies from the quicksand. The idea here is to generate across-the-board wage increases, perhaps by using tax incentives, to induce a wage-price spiral of the sort that, in the 1970s, policymakers struggled to escape.
All this involves risks. A world of helicopter drops is anathema to many: monetary financing is prohibited by the treaties underpinning the euro, for example. Incomes policies are even more problematic, as they reduce flexibility and are hard to reverse. But if the rich world ends up stuck in deflation, the time will come to contemplate extreme action, particularly in the most benighted economies, such as Japan’s.
Elsewhere, governments can make use of a less risky tool: fiscal policy. Too many countries with room to borrow more, notably Germany, have held back. Such Swabian frugality is deeply harmful. Borrowing has never been cheaper. Yields on more than $7 trillion of government bonds worldwide are now negative. Bond markets and ratings agencies will look more kindly on the increase in public debt if there are fresh and productive assets on the other side of the balance-sheet. Above all, such assets should involve infrastructure. The case for locking in long-term funding to finance a multi-year programme to rebuild and improve tatty public roads and buildings has never been more powerful.
A fiscal boost would pack more of a punch if it was coupled with structural reforms that work with the grain of the stimulus. European banks’ balance-sheets still need strengthening and, so long as questions swirl about their health, the banks will not lend freely. Write-downs of bad debts are one option, but it might be better to overhaul the rules so that governments can insist that banks either raise capital or have equity forced on them by regulators.
Deregulation is another priority—and no less potent for being familiar. The Council of Economic Advisors says that the share of America’s workforce covered by state-licensing laws has risen to 25%, from 5% in the 1950s. Much of this red tape is unnecessary. Zoning laws are a barrier to new infrastructure. Tax codes remain Byzantine and stuffed with carve-outs that shelter the income of the better-off, who tend to save more.
America’s political establishment is riven; Japan’s politicians are too timid to confront lobbies; and the euro area seems institutionally incapable of uniting around new policies.
If politicians fail to act now, while they still have time, a full-blown crisis in markets will force action upon them. Although that would be a poor outcome, it would nevertheless be better than the alternative. The greatest worry is that falling markets and stagnant economies hand political power to the populists who have grown strong on the back of the crisis of 2007-08.
Populists have their own solutions to economic hardship, which include protectionist tariffs, windfall taxes, nationalisation and any number of ruinous schemes.
Behind the worry that central banks can no longer exert control is an even deeper fear. It is that liberal, centrist politicians are not up to the job.