Macroeconomics

The world economy’s strange new rules

How rich-world economies work has changed radically. So must economic policy




RICH-WORLD economies consist of a billion consumers and millions of firms taking their own decisions. But they also feature mighty public institutions that try to steer the economy, including central banks, which set monetary policy, and governments, which decide how much to spend and borrow. For the past 30 years or more these institutions have run under established rules. The government wants a booming jobs market that wins votes but, if the economy overheats, it will cause inflation.

And so independent central banks are needed to take away the punch bowl just as the party warms up, to borrow the familiar quip of William McChesney Martin, once head of the Federal Reserve. Think of it as a division of labour: politicians focus on the long-term size of the state and myriad other priorities. Technocrats have the tricky job of taming the business cycle.

This neat arrangement is collapsing. As our special report explains, the link between lower unemployment and higher inflation has gone missing. Most of the rich world is enjoying a jobs boom even as central banks undershoot inflation targets. America’s jobless rate, at 3.5%, is the lowest since 1969, but inflation is only 1.4%. Interest rates are so low that central banks have little room to cut should recession strike.

Even now some are still trying to support demand with quantitative easing (QE), ie, buying bonds. This strange state of affairs once looked temporary, but it has become the new normal.

As a result the rules of economic policy need redrafting—and, in particular, the division of labour between central banks and governments. That process is already fraught. It could yet become dangerous.

The new era of economic policy has its roots in the financial crisis of 2007-09. Central banks enacted temporary and extraordinary measures such as QE to avoid a depression. But it has since become clear that deep forces are at work. Inflation no longer rises reliably when unemployment is low, partly because the public has come to expect modest price rises, and also because global supply chains mean prices do not always reflect local labour-market conditions.

At the same time an excess of savings and firms’ reluctance to invest have pushed interest rates down. So insatiable is the global appetite to save that more than a quarter of all investment-grade bonds, worth $15trn, now have negative yields, meaning lenders must pay to hold them to maturity.

Economists and officials have struggled to adapt. In early 2012 most Fed officials thought that interest rates in America would settle at over 4%. Nearly eight years on they are just 1.75-2% and are the highest in the G7. A decade ago, almost all policymakers and investors thought that central banks would eventually unwind QE by selling bonds or letting their holdings mature. Now the policy seems permanent.

The combined balance-sheets of central banks in America, the euro zone, Britain and Japan stand at over 35% of their total GDP. The European Central Bank (ECB), desperate to boost inflation, is restarting QE. For a while the Fed managed to shrink its balance-sheet, but since September its assets have started to grow again as it has injected liquidity into wobbly money-markets. On October 8th Jerome Powell, the Fed’s chairman, confirmed that this growth would continue.

One implication of this new world is obvious. As central banks run out of ways to stimulate the economy when it flags, more of the heavy lifting will fall to tax cuts and public spending. Because interest rates are so low, or negative, high public debt is more sustainable, particularly if borrowing is used to finance long-term investments that boost growth, such as infrastructure.

Yet recent fiscal policy has been confused and sometimes damaging. Germany has failed to improve its decaying roads and bridges. Britain cut budgets deeply in the early 2010s while its economy was weak—its lack of public investment is one reason for its chronically low productivity growth. America is running a bigger-than-average deficit, but to fund tax cuts for firms and the wealthy, rather than road repairs or green power-grids.

While incumbent politicians struggle to deploy fiscal policy appropriately, those who have yet to win office are eyeing central banks as a convenient source of cash. “Modern monetary theory”, a wacky notion that is gaining popularity on America’s left, says there are no costs to expanding government spending while inflation is low—so long as the central bank is supine. (President Donald Trump’s attacks on the Fed make it more vulnerable.)

Britain’s opposition Labour Party wants to use the Bank of England to direct credit through an investment board, “bringing together” the roles of chancellor, business minister and Bank of England governor.

In a mirror image, central banks are starting to encroach on fiscal policy, the territory of governments. The Bank of Japan’s massive bondholdings prop up a public debt of nearly 240% of GDP. In the euro area QE and low rates provide budgetary relief to indebted southern countries—which this month provoked a stinging attack on the central bank by some prominent northern economists and former officials.

Mario Draghi, the ECB’s outgoing president, has made public appeals for fiscal stimulus in the euro zone. Some economists think central banks need fiscal levers they can pull themselves.

Here lies the danger in the fusion of monetary and fiscal policy. Just as politicians are tempted to meddle with central banks, so the technocrats will take decisions that are the rightful domain of politicians.

If they control fiscal levers, how much money should they give to the poor? What investments should they make? What share of the economy should belong to the state?

A new frontier

In downturns either governments or central banks will need to administer a prompt, powerful but limited fiscal stimulus. One idea is to beef up the government’s automatic fiscal stabilisers, such as unemployment insurance, that guarantee bigger deficits if the economy stalls.

Another is to give central banks a fiscal tool that does not try to redistribute money, and hence does not invite a feeding frenzy at the printing presses—by, say, transferring an equal amount into the bank account of every adult citizen when the economy slumps.

Each path brings risks. But the old arrangement no longer works. The institutions that steer the economy must be remade for today’s strange new world.


Investors are addicted to the QE placebo

The collapse in inflation expectations is a sign of waning faith in central Banks

Tommy Stubbington

Montage of Mario Draghi and the ECB in Frankfurt. The central bank's president asked last month that governments loosen the purse strings to complement its stimulus.
Mario Draghi gave his most forceful plea yet last month for governments to loosen the purse strings to complement the ECB's stimulus, which investors believe is an admission that the central bank is running low on ammunition



Ever since the European Central Bank’s president Mario Draghi began to stoke expectations of further stimulus back in June, investors have been betting heavily on two things: that more quantitative easing is on its way, and that it will not work.

Now that Mr Draghi has delivered his parting shot from the ECB by cutting rates and resuming bond-buying to the tune of €20bn a month, markets have doubled down on those bets.

A key gauge of inflation expectations in the eurozone, which is closely watched by the ECB’s governing council, fell to an all-time low this week. The so-called five-year five-year inflation forward — which measures how much annual inflation markets are pricing in over the second half of the coming decade — sank below 1.11 per cent.

Much analysis of the latest stimulus move has focused on whether Mr Draghi could “over-deliver” by further stoking a rally in eurozone government bonds that has pushed yields to record lows — or at least, not cause it to go into reverse.

On that basis, September’s easing package can be counted a modest success. A bond rally that looked to have stalled ahead of the meeting has since resumed. Many investors are already betting on further rate cuts, or expecting Mr Draghi’s successor Christine Lagarde to assert her authority by beefing up the QE programme.

But for a central bank whose only mandate is to keep inflation below but close to 2 per cent, it is a strange kind of success. The eurozone rate slipped below 1 per cent in September. Stimulus may be good for bond investors’ portfolios, but appears to have little impact on their inflation expectations.

Buying 30-year German debt at a sub-zero yield looks like an odd trade at the best of times. If you expect the ECB to get anywhere near its target over the next three decades, it looks downright foolish.

Richard Barwell, head of macro research at BNP Paribas Asset Management, likens investors to a patient knowingly demanding a placebo: “The bond market is adamant it needs stimulus, but equally adamant it doesn’t work,” he said.

If investors believe monetary easing no longer has much impact — a view shared by a growing number of economists — then why keep doing it?

Mr Draghi pointed out in his interview with the FT last month that tumbling inflation expectations are not confined to the euro area. While it is true that US inflation forwards have also sunk alarmingly this year, it is less clear why the ECB should take comfort. The collapse is a sign of investors’ waning faith in the power of central banks everywhere.

The outgoing ECB head denied the central bank is out of ammunition, arguing more could be done with both interest rates and asset purchases. But Mr Draghi also gave his most forceful plea yet for governments to loosen the purse strings to complement the central bank’s own stimulus. While he would never say so directly, to many investors this sounds like a tacit admission the ECB is running low on bullets.

Markets seem to agree that, at this point, fiscal stimulus offers more bang for its buck than further monetary easing. Hints in August and September that the German government was considering ditching its cast-iron commitment to a balanced budget caused brief bond market wobbles.

A full-blown commitment by Berlin to borrow and spend would no doubt have a much bigger impact on both the economy and the expected path of inflation. Bond markets in Germany and beyond would no doubt feel the pain as they were forced to digest greater issuance of bonds to fund any spending splurge. In that light, the clamour for negative-yielding debt suggests investors are not really expecting much on the fiscal front.

These dynamics are playing out amid an almighty row over Mr Draghi’s final policy moves. Central bankers from Germany, Austria and the Netherlands have all joined the German tabloid press in publicly criticising the ECB’s stimulus package. The boss of Europe’s biggest insurer, Allianz, lambasted the Italian for his “politicisation” of monetary policy.

There is little logic to these calls for higher interest rates. Negative rates and QE have not pushed inflation back to target, but things could always be worse. Without them the eurozone might soon be facing the spectre of deflation. But they are another sign that the negative side-effects of monetary policy are coming into focus as its effectiveness wanes.

If Ms Lagarde goes down the path of further stimulus, the calls will grow louder. Some ECB policymakers may even calculate that causing further discomfort could become the main point of QE and negative rates: dish out enough pain to German savers and Berlin may shift its stance on fiscal policy.

It might just work, but it is a dangerous game, both for an increasingly political ECB, and for bond investors.

Does Public Banking Work?

While some on the right will decry California's recently enacted public-banking law as an invitation to government profligacy, the history of publicly-owned lending institutions shows that they can play a valuable role in addressing needs left unmet by the market. The key to success lies in governance and avoiding mission drift.

Katharina Pistor

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NEW YORK – Three decades after the fall of the Berlin Wall, the United States is finally embracing public banking. In the summer of 1989, political theorist Francis Fukuyama famously suggested that American-style free-market capitalism would become the default mode for organizing economies around the world. But now policymakers in that model’s very heartland are looking for alternatives.

Unlike many other countries around the world, the US has never had a sizable public-banking sector.

But as of this month, public banks are legal in California, making it the second (after North Dakota) and largest state to have embraced the idea. California lawmakers recently enacted legislation that officially authorizes “public ownership of public banks for the purpose of achieving cost savings, strengthening local economies, supporting community economic development, and addressing infrastructure and housing needs for localities.”

Judging by the text of the law, California’s public banks will be more limited in scope than public-banking sectors elsewhere. They will be local, not-for-profit entities with a designated public purpose. Some may operate as commercial banks, accepting deposits and making loans; and others may serve as industrial banks with a focus on infrastructure investments.

In any case, California’s public banks will establish a funding base through deposits or loans from local governments across the state. As public institutions, they will be exempt from taxes and certain disclosure requirements. But in all other respects, they will be treated like ordinary banks. They must obtain a banking license and deposit insurance, and they will be required to appoint management with the requisite knowledge and expertise to run a bank.

Will it work? The global and historical experience with public banking suggests that, just as in the private sector, some public banks will achieve most of their goals most of the time, while others will underperform or even fail. Public ownership in itself does not lead to bad outcomes; nor has privatization proven to be the panacea that its boosters promised. Much depends on governance and the clarity of the stipulated goals. Checks and balances are needed to keep management on track, and the managers themselves must have the right skill set.

But whether public banks will work is not really the right question to ask. More important is whether they will stay on mission. As Kent State’s Mark K. Cassell shows, “mission shift” within public banks has been common historically, and a failure to prevent it, or to adapt the governance regime accordingly, can create disruptions that result in crises.

In fact, America’s own history of public banking offers evidence of this tendency. Consider the fate of Fannie Mae – the Federal National Mortgage Association – which was established in 1938 as a publicly owned mortgage bank. In 1968, Congress amended Fannie’s charter and privatized it, turning it into a hybrid entity.

Thenceforth, it had a public mission (ensuring affordable home ownership), but was owned by profit-seeking shareholders and indirectly subsidized by an implicit government guarantee that lowered its cost of debt finance. This did not end well. Fannie Mae – together with its younger sibling, Freddie Mac (the Federal Home Loan Mortgage Corporation) – had to be put on life support in 2008.

Similarly, many of Germany’s Landesbanken, which date back two centuries, required government bailouts in the 2008 crisis. Originally, each bank’s operations were confined to the boundaries of its state (or Land). After World War II, the Landesbanken were re-constituted as regional banks and tasked with assisting post-war reconstruction and development efforts.

They were not required to maximize profits, and yet they were reorganized as for-profit institutions. And while they were subject, in principle, to the same regulations as privately-owned banks, it became the practice of federal bank regulators to leave oversight largely to the individual states, which were the ultimate risk bearers.

As with Fannie Mae, the Landesbanken embarked on a mission shift which left them with a completely inadequate governance structure. In their case, though, the problems stemmed not so much from a legal change as from managerial ambition. Some Landesbanken began to internationalize in the 1980s and invest in fancy financial products, and the others soon followed suit.

State governments did little about this because they were benefiting from the additional revenue. Regulation remained as lax as before, and politicians continued to populate Landesbanken boards. In the end, this left them even more vulnerable to the crisis, and helped increase the price tag for their bailouts relative to private banks.

The main lessons, then, are that public purpose does not mesh well with profit maximization, and a one-time commitment to public ownership and/or a public purpose is not enough. The banks must be governed well to stay on mission, and the governance regime itself must be monitored to ensure that it remains both effective and complementary to that mission.

At the end of the day, mission drift may be unavoidable. But detecting it and instituting the necessary governance reforms is well within governments’ power. It would be a tragic mistake to assume that passing a public-banking law amounts to “mission accomplished.” The mission has only just begun.


Katharina Pistor is Professor of Comparative Law at Columbia Law School and the author of The Code of Capital: How the Law Creates Wealth and Inequality.

This Is a Constitutional Crisis. What Happens Next?

With a full-on confrontation between the House and the president, no simple resolution is available.

By Noah Feldman


The White House.CreditCreditSamuel Corum for The New York Times


For the first time since President Richard Nixon refused to turn over the White House tapes, the United States is facing a genuine constitutional crisis.

To be sure, Donald Trump had already created a crisis in the presidency by abusing the power of his office to pressure foreign governments to investigate his political rival Joe Biden. But that act on its own didn’t count as a constitutional crisis, because the Constitution prescribes an answer to presidential abuse of office: impeachment.

Now that President Trump has announced — via a letter signed by Pat Cipollone, the White House counsel — that he will not cooperate in any way with the impeachment inquiry begun in the House of Representatives, we no longer have just a crisis of the presidency. We also have a breakdown in the fundamental structure of government under the Constitution. That counts as a constitutional crisis.

A constitutional crisis exists when two conditions hold. First, we face a situation where the Constitution does not provide a clear, definitive answer to a basic problem of governance. Second, the political actors whose conflict is creating the problem appear ready to press their competing courses of action to the limit.

With Watergate, those two conditions were met. When President Nixon refused to comply with a valid subpoena issued by a federal court, there was no clear answer in the Constitution as to which branch of government would prevail. Mr. Nixon wouldn’t budge, and neither the special prosecutor nor the court was willing to back down. The crisis was resolved only after the Supreme Court ordered the tapes to be turned over and Mr. Nixon resigned.

President Trump’s stonewalling of the House impeachment inquiry also satisfies the two conditions for a constitutional crisis. First, the Constitution doesn’t indicate what is supposed to happen if the House tries to exercise its constitutional power of oversight to investigate the president and the president flatly rejects the House’s constitutional authority. Congress can demand that the president comply, but it can’t very well send its sergeant-at-arms to the White House to enforce its subpoenas.

You might say that under the Constitution, the House could justifiably impeach the president for refusing to participate in the impeachment inquiry. Indeed, the third article of impeachment adopted by the House Judiciary Committee against Mr. Nixon charged him with contempt of Congress for ignoring subpoenas issued by Congress.

Yet as Mr. Trump appears to be calculating, it’s not so simple or satisfying for the House to proceed to impeachment without a factual inquiry. Impeaching a president for refusing to participate in an impeachment inquiry is a kind of meta-impeachment. It would allow Mr. Trump to argue that the meta-impeachment is illegitimate because it isn’t based on an investigation.

That brings us to the second condition, namely that neither of the key actors seems prepared to back down. About the only thing the House could do now would be to pass a resolution formally authorizing the impeachment inquiry — something it has not yet done and which the White House counsel cited in his letter as a reason to consider the current inquiry “unprecedented.” Passing such a resolution might be a good idea for the House. But it would not qualify as backing down. To the contrary, passing a resolution to investigate impeachment would raise the stakes in the constitutional confrontation.

Mr. Trump, for his part, could in theory back down once the House passes such a resolution and start cooperating in the inquiry. That would avert the crisis. It’s just barely conceivable that the motivation for the White House counsel’s letter was to force House Democrats to go on the record individually as supporting an impeachment inquiry.

The White House counsel’s letter, however, strongly signals that Mr. Trump won’t start cooperating even if the House passes a resolution to authorize the inquiry. The letter makes a number of independent arguments for why the current impeachment inquiry is unconstitutional and illegitimate, and those would presumably still apply even if the House passed a resolution authorizing the inquiry.

Assuming that Mr. Trump isn’t backing down, we’re witnessing a full-on confrontation between the House and the president, with no simple resolution available.

When two branches of government are locked in a standoff, it’s always possible that the third branch of government might come in to resolve it. In this instance, that’s the judiciary, and the Supreme Court is the obvious candidate for the role. Faced with presidential refusal to comply with subpoenas, the House could seek judicial enforcement of its subpoenas.

As a matter of ordinary constitutional law, there’s little doubt that the House’s arguments before the courts would be much stronger than any offered in Mr. Cipollone’s letter. It’s well-settled constitutional doctrine that Congress may issue subpoenas for any valid legislative purpose. The Constitution gives the House the power to impeach. An impeachment inquiry is therefore a valid legislative purpose under the Constitution — and impeachment-related subpoenas should be enforced by the courts.

The president could always assert executive privilege with respect to particular confidential documents. Such claims of privilege could be analyzed by the courts under existing constitutional precedents. There is no precedent in constitutional doctrine, however, supporting a president’s blanket refusal to comply with any subpoenas regardless of privilege.

More to the point, Mr. Cipollone’s letter presents the president as the judge of whether a congressional inquiry into impeachment is constitutional. That obviously can’t be right. Not only would that violate the principle of separation of powers; it also would effectively put the president in ultimate control of the impeachment process.

Given the extreme weakness of Mr. Trump’s arguments, it’s probable that the lower federal courts would side with the House. Going to the Supreme Court, however, is always a bit of a gamble. The court’s four more-liberal justices would undoubtedly side with the House. The court’s four most conservative justices, two of them appointed by Mr. Trump, would find themselves in a quandary. Given the weakness of Mr. Trump’s arguments, it’s possible to imagine that they would take the position that the judicial branch should abstain from a conflict between the other two branches — a way of dodging the issue that would effectively allow them to give Mr. Trump a victory.

That would leave the balance of power with Chief Justice John Roberts, who is a judicial conservative but above all wants to protect the court from appearing partisan. The trouble is, there would be almost no way for the Supreme Court to resolve the current crisis without seeming as though it was taking a side in a political fight.

What would happen? A good guess is that Chief Justice Roberts, with his back to the wall, would stand up for the clear constitutional precedent that says the courts will enforce valid congressional subpoenas. The Supreme Court chose the rule of law over President Nixon, a precedent that will not be lost on Justice Roberts.

But a guess is not constitutional reassurance. And in a constitutional crisis, that kind of reassurance is what the Republic needs.


Noah Feldman (@NoahRFeldman) is a law professor at Harvard, a columnist for Bloomberg Opinion and the host of the podcast “Deep Background.”