Across the North Atlantic region, central bankers andgovernments seem, for the most part, helpless in restoring full employment totheir economies. Europe has slipped back into recession without ever reallyrecovering from the financial/sovereign-debt crisis that began in 2008. TheUnited States’ economy is currently growing at 1.5% per year (about a fullpercentage point less than potential), and growth may slow, owing to a smallfiscal contraction this year.
Industrial market economies have been suffering fromperiodic financial crises, followed by high unemployment, at least since thePanic of 1825 nearly caused the Bank of England to collapse. Such episodes arebad for everybody – workers who lose their jobs, entrepreneurs and equityholders who lose their profits, governments that lose their tax revenue, andbondholders who suffer the consequences of bankruptcy – and we have had nearlytwo centuries to figure out how to deal with them. So why have governments andcentral banks failed?
There are three reasons why the authorities might fail torestore full employment rapidly after a downturn.For starters, unanchored inflation expectationsand structural difficulties might mean that efforts to boost demand show upalmost entirely in faster price growth and only minimally in higher employment.That was the problem in the 1970’s, but it is not the problem now.
The second reason might be that even with anchored inflation expectations (and thus pricestability), policymakers do not know how to keep them anchored while boostingthe flow of spending in the economy.
And here I stop, flummoxed.At least as I read the history, by 1829, Western Europe’s technocraticeconomists had figured out why these periodic grand maleconomic seizures occurred. That year,Jean-Baptiste Say published his Cours Complet d’Economie Politique Pratique, admitting thatThomas Malthus had been at least half right in arguing that an economy couldsuffer for years from a “general glut” ofcommodities, with nearly everybody trying to reduce spending below income – intoday’s jargon, to deleverage.And, because one person’s spending is another’s income,universal deleveraging produces only depressionand high unemployment.
Over the following century, economists like John StuartMill, Walter Bagehot, Irving Fisher, Knut Wicksell, and John Maynard Keynesdevised a list of steps to take in order to avoid or cure a depression.
1. Don’t go there in the first place: avoid whatever it is– whether external pressure under the gold standard, asset-price bubbles, orleverage-and-panic cycles such as that of 2003-2009 – that creates the desireto deleverage.
2. If you do find yourself there, stop the desire todeleverage by having the central bank buy bonds for cash, thereby pushing downinterest rates, so that holding debt becomes more attractive than holding cash.
3. If you still find yourself there, stop the desire todeleverage by having the Treasury guarantee risky assets, or issue safe ones,in order to raise the quality of debt in the market; this, too, will makeholding debt more attractive.
4. If that fails, stop the desire to deleverage bypromising to print more money in the future, which would raise the rate ofinflation and make holding cash less attractive than spending it.
5. In the worst case, have the government step in, borrowmoney, and buy stuff, thereby rebalancing the economy as the private sectordeleverages.
There are many subtleties inhow governments and central banks should attempt to accomplish these steps.And, indeed, the North Atlantic region’s governments and central banks havetried to some degree. But it is clear that they have not tried enough: the“stop” signal of unanchored inflationexpectations, accelerating price growth, and spiking long-term interest rates –all of which tell us that we have reached the structuraland expectational limits of expansionary policy – has not yet been flashed.
So we remain far short of fullemployment for the third reason. The issue is not that governments and centralbanks cannot restore employment, or do not know how; it is that governments andcentral banks will not take expansionary policy steps on a large enough scaleto restore full employment rapidly.
And here I reflect on the 1930’s, and on how historicalevents recur, appearing first as tragedy and then, pace Karl Marx, as yet another tragedy.Keynes begged the policymakers of his time to ignore the “austere and puritanicalsouls” who argue for “what they politely call a ‘prolonged liquidation’ to putus right,” and professed that he could “not understand how universal bankruptcycan do any good or bring us nearer to prosperity.”
Today’s policymakers, so eager to draw a bold line under expansionary measures, should pause and consider the same question.