Monetary and Fiscal Policy and Structural Reform: Each Had a Role to Play after the Financial Crisis

With fiscal policy hamstrung by public debt in both the E.U. and U.S., monetary policy was a major beneficiary of the financial crisis of 2008 and the ensuing state-debt crisis that stammered on at least until 2013 in Europe. Lest it be concluded that central bank policy had reached an unassailable peak of salvation, the expanded role actually made its limitations transparent, at least in financial circles.
Speaking to Charlie Rose on March 11, 2013, Jeremy Grantham of a Wall Street firm argued that the U.S. Federal Reserve Bank's extremely low interest-rate policy would be unlikely to spark an increase in employment even in the severe recession following the financial crisis. In fact, a low interest rate is a transfer of wealth from the poor to the rich. Fiscal policy, such as the Conservation Civilians Corps of U.S. President Franklin Roosevelt's New Deal in the 1930s, is a much better tool to achieve full employment. Yet even the New Deal did not have enough fire-power to bring the U.S. economy out of the Great Depression; it took the breaking out of a second world war to get America's military-industrial complex to create enough jobs. One implication is that a competitive market alone is not sufficient to reach full employment. Even though such a market can sport great efficiency if kept competitive by the enforcement of anti-trust law, natural consumption levels have been unable to spark enough jobs for full employment to be achieved. Not even low interest rates can do that, as per the decade of the 2010's. We ought to accept that a lot of fiscal stimulus is needed to achieve full employment, even if it is not optimally efficient. 
Meanwhile, Jens Weidmann, the president of the Bundesbank, argued that monetary policy in the E.U. “can only buy time at best..” He went on to say he was “a bit concerned about some of the expectations around the power and potential of monetary policy.”[1] In other words, the ECB should have gotten back to monetary policy in a stricter sense, rather than trying to spark economic growth and employment through low interest rates and buying state-government bonds.
Behind the view of interest-rate, or monetary, policy as being capable of giving us economic salvation was the paralysis of fiscal policy determination in both federal unions.  Divided government at the federal level stymied fiscal policy in the U.S. after President Obama’s insufficient “stimulus” package in 2010. In the E.U., the vetoes retained by the fiscally- and debt-conservative state governments such as Germany at the federal level through the European Council put pressure on state governments strapped fiscally to take on even more debt even just to avoid defaulting on existing debt, not to mention keeping their fiscal policy-levels sufficient that their residents would not be imperiled. Increasing debt-loads for fiscal reasons did not serve states like Greece and Spain well. Fiscal redistribution at the federal level is one of the benefits of federalism, and yet the E.U. was stymied because each state government had too much power at the federal level (quite unlike the states in the U.S. at its federal level). 
In short, much of the allure of monetary policy actually came from fiscal frustration at the federal levels of both unions. Alternatively, both fiscal and monetary policy could have been used, and pointed in the same direction: toward full employment. Using low interest rates and the issuance of debt, respectively, to pull up an economy out of severe recession and even as political coverage (in the U.S.) or leverage (in the E.U.) for needed structural reforms of a financial system and indebted states, respectively, may not have been sufficient or even smart. Taking on a corruption-induced financial system in the U.S. required a lot of political guts, which not even the Obama administration had, for the Dodd-Frank Act of 2010 did not go far enough in deconstructing the conflicts of interest in the system. Also, feeding Wall Street with infusions of government money appropriated by Congress and much more created by the Federal Reserve Bank, with no strings attached, did not make the bankers at the big banks any more willing to accept structural reforms even though they would have protected the banks by fixing the system. Not even fiscal stimulus plus low interest rates could keep the U.S. out of a severe recession, though arguably the U.S. could have entered a severe depression otherwise. Both fiscal and monetary policy and going politically after dysfunctional systems, whether that of Wall Street or those of heavily-indebted E.U. states, all must be used so none of the tools is over-relied upon and thus overused.  

See Institutional Conflicts of Interest, Essays on the Financial Crisis, and Essays on the E.U. Political Economy. All are available at Amazon.

1. Katy Barnato, “Central Banks Alone Can’t Fix Europe: Weidmann,” CNBC, March 12, 2013.  

Is Modest Growth vs. Full Employment a False Dichotomy?

As Summer slid into Autumn in 2012, the Chinese government was giving no hint of any ensuing economic stimulus program. This was more than slightly unnerving for some, as a recent manufacturing survey had slumped more than expected, to 49.2 in August. A score of 50 separated expansion from contraction. A similar survey, by HSBC, came in at 47.6, down from 49.3 the previous month. Bloomberg suggested that China might face a recession in the third quarter. So why no stimulus announcement?  Was the Chinese government really just one giant tease? I submit that the false dichotomy of moderate economic growth and full employment was in play. In short, the Chinese government did not want to over-heat even a stagnant economy even though the assumption was that full employment would thus not be realizable.

Wang Tao, an economist at UBS, explained the “very reactionary, cautious approach” as being motivated by the desire to avoid repeating the “excesses of last time.”[1] The stimulus policy in the wake of the 2008 global downturn had sparked inflation and caused a housing bubble in China. According to The New York Times, China was avoiding “measures that could reignite another investment binge of the sort that sent prices for property and other assets soaring in 2009 and 2010.”[2] A repeat of any such binge could not be good, for it can spark the sort of irrational excitement that have a life of its own.
In short, too much stimulus in an economy can cause inflation and put people’s homes at risk of foreclosure once the housing bubble bursts, whereas a lack of stimulus means that a moderate growth rate is likely, rather one that could give rise to full employment. Is there no way out of this trade-off? 
Keeping fiscal or monetary stimulus within projections of a moderate growth can occur with more government spending targeted to a combination of giving private employers a financial incentive to hire more people and increasing the number of people hired by state enterprises. In principle with the Full Employment Act of the U.S. in 1946, a government can see that anyone who wants a job has one, while still maintaining a moderate stimulus. A modest growth-rate can co-exist with full employment. 

1, Bettina Wassener, “As Growth Flags, China Shies From Stimulus,” The New York Times, September 3, 2012. 
2. Ibid.

Should the ECB Buy State Bonds and Encourage State Deficits?

In remarks at Jackson Hole, Wyoming, European Central Bank president Mario Draghi urged greater fiscal and monetary coordination to boost the E.U.’s economy. A ship cannot move along at full speed if all the sails are not coordinated so that each is poised at its optimal angle to the prevailing winds. So too, various policies in a political economy must all sail in the same direction for a full-sail recovery to really take off. Just as a sailing ship must avoid jagged pitfalls lurking in rocky waters, so too must policy makers; for it is all too easy in focusing on one point on the horizon to ignore or dismiss baleful downsides to the dominant policies.

At the foot of the Teton Mountains, there being no foothills, Draghi “called for explicit policy co-ordination between the [Eurozone’s] monetary guardian and [the states].”[1] Brandishing considerably less concern on inflation, he linked the ECB’s future purchases of state bonds (i.e., quantitative easing, or QE) to structural reforms, tax cuts, and more spending at the state level. 

At the time, E.U. law limited state budget deficits to 3% of gross domestic product. Pointing to the existing flexibility in that law, the central banker urged the state governors to “better address the weak recovery and to make room for the cost of needed structural reforms.”[2] I submit that the accent should be placed on the latter, as they would have more staying power. It is like the difference between consuming sugar (even in fruit) before running, and drinking a protein shake after lifting weights; both food elements are helpful, but only the protein becomes a part the body and can thus strengthen it for the future.

Quantitative easing can unfortunately impact an economy in both foreseen and unforeseen ways due to the intended artificially-low interest rates. The market-mechanism cannot but be distorted, with harsh byproducts free to silently ravage certain segments while others benefit without merit. The human brain is not so omniscient as to be able to fully anticipate and plug all the leaks that can arise from a systemic distortion in a macro-economy. That is to say, the system is so complex that a huge distortion using one macro policy tool can introduce significant systemic risk.

In the U.S., for example, low rates in the 1990s incentivized a housing bubble whose collapse in 2007 triggered the potentially catastrophic credit freeze and collapse of Lehman Brothers in September of 2008. The government bailout of GM, AIG, and Wall Street banks worsened the federal public debt. By 2014, that debt reached over $17 trillion. Meanwhile, the Federal Reserve printed money far exceeding the meager growth of GDP by buying bonds to artificially lower interest rates to prompt a recovery.

With interest rates low, money flooded into stocks. “The market is in effect rigged because of the [low] interest rate,” Charles Biderman said on CNBC as the summer of 2014 was coming to an end.[3] A grinding ethical fault-line ran between the stocks increasing at 25% a year and the wages and salaries increasing at a mere 3 percent. Moreover, the middle and lower economic classes would doubtless feel the brunt of a collapse of the stock market due to irrational fear should rates be raised to counter the inflation from too many dollars chasing too few goods.

With borrowing money being so cheap at the low rates, government officials did not feel the normal market pressure to hem in the deficits. Corporate managements could borrow money cheaply to acquire or merge with other companies without being perhaps as discerning of the degree of compatibility and synergy as would be the case under naturally determined interest rates. In 2014 through August, more than $2 trillion in mergers and acquisitions were announced—an increase of 70 percent over the same period the year before.[4] While managers, stockholders, and lawyers make out like bandits on the deals, subordinate employees are left out of the largess and may even lose their jobs as the price of synergy.

As dark as the underside of quantitative easing is in pushing rates abnormally low, the most potentially harmful byproduct of Draghi’s plan concerns his intent to encourage the E.U.’s state governments to make greater use of the “existing flexibility” already in the federal law limiting state budget deficits to 3% of annual economic output. Even large states such as France and Germany had had trouble keeping within the law; states such as Greece, Spain, and even Italy carried so much debt that the systemic risk of default became a problem not just for the E.U., but for the global financial system as well. To encourage flexibility might be like giving money to an alcoholic standing outside a liquor store. The last thing state legislators need to hear is additional flexibility to tax less and spend more can be found in the fine print.

As an alternative, Draghi could have emphasized that the ECB would focus on assisting states with structural reforms both by lending its expertise and finding the right monetary incentives that would not distort the financial market in potentially unforeseen ways. Sticking to old ways is not necessarily the best route to getting structural changes capable of ushering in new ways.

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1. Claire Jones, Peter Spiegel, and Robin Harding, “Draghi Softens Tone on Austerity,” The Financial Times, August 22, 2014.

2. Ibid.

3. Charles Biderman, CNBC TV, August 28, 2104.

4. Trish Regan, “Has Fed Jumped the Shark?” USA Today, August 26, 2014.