Night Thoughts on Martin Wolf’s Shocking Shifts: Daily Focus
Martin Wolf’s column this week contains a very nice precis of the main argument of his recent The Shifts and the Shocks:
…over more than six years is pathetic by historical standards–occurred despite the most aggressive monetary policies in history…. Yet this has not been nearly enough…. How do we explain such weak demand?… Three sets…. The first… stresses the post-crisis overhang of private debt and the damage to confidence caused by the sudden disintegration of the financial system…. The second… argues that the pre-crisis demand was unsustainable because it relied on huge accumulations of private and public debt…. The implication of this is that economies suffer not just from a post-crisis balance-sheet recession, but from an inability to generate credit-driven demand on the pre-crisis scale. Behind the unsustainability of pre-crisis demand lie global imbalances, shifts in income distribution and structurally weak investment…. The third set… points to a slowdown in potential growth, due to some combination of demographic changes, slowing rises in productivity and weak investment… feeds directly into the second…. The reason that extreme policy has been so ineffective is that the economies suffer from such deep-seated ailments. It is not just about weak supply. But it is also not just about weak demand. Nor is it just about the debt overhang or financial shocks. Each economy also has a different combination of ailments…
The deep-seated ailments that Wolf identifies are, I think, sixfold:
- In economic reality: the great rise in income and wealth inequality, with its consequent pressures for (i) overleverage and (ii) volatility of demand–the non-rich are pressured to spend by their needs for the necessities and their desires for the conveniences of life, while the rich are not.
- In economic reality: the emergence of the emerging-market liberalization, technological globalization, and first-world aging-driven “global savings glut”–or perhaps the global investment shortage–with its consequent extraordinary rise in global demand for assets perceived to be safe.
- In economic theory: the “insouciance” generated by the rational-expectations and efficient-markets hypotheses that produced a deep skepticism of pragmatic regulation to minimize systemic risk, a skepticism apparently and temporarily confirmed by the fact of the Great Moderation.
- In economic policy: the resulting production of both the deregulation of the 2000s that made it easy to sell assets perceived to be safe that were not in fact so, and the policy-making climate in which it apparently made sense in 2008 and since to do what was but no more than necessary to handle the crisis.
- In finance: the fact that tail risks had not been realized for generations meant that they were underweighted and portfolios were not properly hedged: as Minsky said, the fact of past stability destabilizes the future.
- In economic policy: the hubris of settling on a 2%/year inflation target as providing enough sea-room, and the greater hubris of the euro–the creation of a single currency over an area vastly greater than any optimum currency area, especially when coupled with the absence of the fiscal-union and banking-union supports that might have provided safety valves and with the assignment of a leading role in the eurozone to a Germany hag-ridden by an economic episteme that made the maintenance of aggregate demand always somebody else’s problem.
The financial crisis that hit the North Atlantic in 2008 hit a world economy that had just undergone these six shifts, and the consequence was a disaster that looks like it has permanently robbed the North Atlantic of about 10% of its wealth.
As to what ought to be done right now in the short run to try to recoup at least part of that permanent wealth-destruction, my reading of Martin Wolf’s book leads me to believe that he sees, as I see:
- A North Atlantic desperately short of both public and other long-term investment spending.
- A North Atlantic in which a continued shortage of supply of safe assets relative to demand at full employment puts downward pressure on spending.
- A North Atlantic in which the sub-2%/year trend of inflation creates unjustifiable risks of the ZLB trap, and even worse, unjustifiable risks of deflation.
These seem to me at least to call for easy solutions:
- Reserve-currency issuing governments that increase their investment spending and increase their guarantees of long-term investments.
- Reserve-currency issuing governments that finance these increased spending projects by issuing high-quality debt to resolve the safe asset shortage.
- Reserve-currency issuing governments that monetize enough of this debt to raise the trend inflation rate from 2%/year to 3%/year or 4%/year.
As to what ought to be done in the medium run, Martin calls for:
- “The Eurozone [to] confront an existential challenge… decide either to break up… or to create a minimum set of institutions and policies that would make it work…”
- Strong regulatory mandates to greatly diminish leverage and the use of debt.
I certainly agree with the first–but I see no political road to the creation of even the minimum set of institutions and policies in the eurozone.
I am less sure about the second. Debt is a very useful social instrumentality: we do not want everyone to have to pay all the attention all the time to all of their investments that we demand of prudent equity-holders. A focus on making sure that debts are good via aggressive stress-testing coupled with prudent government backstops via resolution mechanisms, guarantees, and aggregate spending targeting feels better to me. Yes, I know that this means that at times the government will wind up paying money out to feckless lenders and the government will thus provide business opportunities to feckless borrowers. But this ain’t a morality play: credit card companies do not attempt to eliminate credit card fraud but simply to balance its costs against the provision of convenience to their customers. Governments should have the same attitude toward the regulation of debt and risk.
And for the long run, Martin calls for:
- A more equal distribution of income and wealth.
- A better economics–one less in thrall to rational-expectations and efficient-market ideologues.
- “More globalization and less–more global regulation and cooperation, and more freedom for individual countries to craft their own responses to the pressures of a globalizing world…”
- Additional reforms of finance that diminish “its role in generating property bubbles… [as] the leveraging up of the stock of land is a consistently destabilizing phenomenon…”
I suspect that the fourth of these looms large in Martin’s mental universe simply because he is based in London. I am not sure it is that big a deal for the world as a whole–my reading of 2008- is that the property booms and busts did not create systemic risk any more than the dot-com boom and bust of the previous decade did, but rather that the critical flaws were elsewhere in high finance.
And as for the other three, the question is: How do we get there? If 2005-2014 does not create a new and very different economics in the universities and among the policy-making community, what would? Today’s superrich and even rich have a very strong material interest in not having a more equal distribution of wealth and income, and they hold a great deal of political power. And when Wolf call for both “more globalization and less” what I hear is a disheartened cry for better policymaking. But we will get that only when we live in Platonis πολιτείᾳ, non in Romuli faece–when we live in the republic of Plato, not in the shit of Romulus.
1275 words