Must-Read: Adair Turner: Debt Déjà Vu

Must-Read: Not that we know what the right model is, mind you. But Adair Turner believes that it is more likely than not that the model the Federal Reserve is currently using to make its forecasts off of–the model that sees steady non-recessionary U.S. economic growth even with imminent interest-rate lift-off–is the wrong model:

Adair Turner: Debt Déjà Vu: “Financial markets have repeated the same error–predicting that US interest rates will rise within about six months…

…This serial misjudgment is the result… of a failure to grasp the strength and global nature of… deflationary forces…. We are caught in a trap where debt burdens do not fall, but simply shift among sectors and countries, and where monetary policies alone are inadequate to stimulate global demand…. The origin of this malaise lies in the creation of excessive debt to fund real-estate investment and construction… during Japan’s 1980s boom… since the financial crisis of 2008… [a] pattern has been repeated elsewhere… in the United States and several European countries…. Advanced economies’ cumulative private debt-to-GDP ratio has fallen slightly–from 167% to 163%… but public debt has grown from 79% to 105% of GDP. Fiscal austerity has therefore seemed essential; but it has exacerbated the deflationary impact of private deleveraging.

Before 2008, China’s economy was highly dependent on credit expansion, but not within the country itself. Rather, it ran large current-account surpluses…. [Starting] in late 2008… China’s government unleashed a massive credit-fueled construction boom… total credit growing from around 140% of GDP to more than 220%. That boom has now ended, leaving apartment blocks in second- and third-tier cities that will never be occupied, and loans to local governments and state-owned enterprises that will never be repaid….

QE alone cannot stimulate enough demand in a world where other major economies are facing the same challenges. By boosting asset prices, QE is meant to spur investment and consumption. But its effectiveness in stimulating domestic demand remains uncertain…. Central bank governors like the ECB’s Mario Draghi and the BOJ’s Haruhiko Kuroda often emphasize QE’s ability to deliver competitive exchange rates. But that approach simply shifts demand from one economy to another…. Seven years after 2008, global leverage is higher than ever, and aggregate global demand is still insufficient to drive robust growth. More radical policies–such as major debt write-downs or increased fiscal deficits financed by permanent monetization–will be required to increase global demand, rather than simply shift it around.

October 21, 2015


Brad DeLong
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