London
BOTH the American economy and the global economy are facing a familiar foe: policy defeatism. Throughout modern economic history, whether in Western Europe in the 1920s, in the United States in the 1930s, or in Japan in the 1990s, every major financial crisis has been followed by premature abandonment — if not reversal — of the stimulus policies that are necessary for sustained recovery. Sadly, the world appears to be repeating this mistake.
The right thing to do right now is for the Federal Reserve and the European Central Bank to engage in further monetary stimulus. Having lowered short-term interest rates, they should buy (or in the case of the Fed, resume buying) significant quantities of government securities to help push down long-term interest rates and encourage investment.
If anything, it is past time for the Fed and its European counterpart to act. The economic outlook has turned out to be as grim as forecasts based on historical evidence predicted it would be, given the nature of the recession, the cutbacks in government spending and the simultaneity of economic problems across the Western world. Sustained high inflation is not a threat in this environment.
As many have observed, we need to rebalance the economy from imports to exports, from private consumption to savings, from tax breaks to infrastructure rebuilding and from the financial sector to everything else. The process of rebalancing will require movement of capital from older industries and activities to newer ones — that is, investment. Moreover, a lot of what was termed “investment” during the boom years was misallocated — wasted — capital, so many productive projects were ignored.
But investment has been held back because of uncertainty over the economy’s future prospects. And the ability to attract investors is being limited by the giant burden of private-sector debt. In other words, a financing problem is inhibiting the restructuring of our economy. Alleviating generalized financing problems and low investor confidence is precisely what monetary stimulus does.
Some claim that monetary easing will impede restructuring. But this makes no sense. For all the talk that monetary austerity promotes the “creative destruction” necessary for the economy to recover, it does not work that way.
In Japan in the 1990s, a period of insufficiently aggressive monetary stimulus fed lending to “zombie companies” — unproductive borrowers on whose loans the banks could not afford to take losses. It was only when macroeconomic policy led a recovery in Japan in the first decade of this century that capital flowed out of the places it had been trapped and into new and growing businesses. Similarly, after the American savings-and-loan crisis, real reallocation of credit from bad banks and borrowers to worthwhile investment began in earnest only when monetary policy eased in the late 1980s.
Another source of policy defeatism is the widespread but false belief that our previous “unconventional” efforts to stimulate the economy either were not terribly effective or are unlikely to be effective if extended today. The fact that the American economy has not fully recovered after previous rounds of stimulus is not evidence that those failed to work at all.
We know that infusions of central bank money to the economy have been closely associated with falling long-term interest rates. We know that the relative price of riskier assets has gone up, indicating greater demand for them, when stimulus has been undertaken. And we know that banks have received increased deposits, and that investors and households have expressed increased confidence, after prior rounds of quantitative easing. That combination has had a stimulative impact, just as a cut in the interest rate would have in ordinary times.
Scientific research tells us that high blood pressure and cholesterol are associated with a higher risk of heart disease and stroke, and that certain prescription medications reduce cholesterol and blood pressure. Yes, it is difficult to prove directly that taking these medicines prevents heart disease and stroke, and taking them is no guarantee of health. But still we should take them, and our doctors should prescribe them if they are indicated. This is the same situation we are in now, with our economy’s financial circulation at risk, and quantitative easing the indicated medicine.
Adam S. Posen, an American economist, is a member of the Monetary Policy Committee of the Bank of England.
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