The recovery from the global financial crisis has been a slow and protracted one, with output levels in many industrialised countries having only recently regained the pre-global financial crisis levels of 2007. Unemployment, and particularly youth unemployment, remains high in many countries and the prospects for growth remain sluggish. The prospects for growth, particularly among the BRICS countries (Brazil, Russia, India, China, and South Africa), are not looking rosy, with a slowdown in growth in China and Brazil into decline.
The central banks’ responses to the global financial crisis and the great recession were to sharply reduce interest rates, and maintain them at very low levels by historic standards, and have tended to move lower and in some cases into negative territory in the past years (the Fed rate rise in December 2015 being an exception). “Unconventional monetary policy” and quantitative easing became widely used, and its intensification in the past few years has pushed actual interest rates even lower. It is now clear that quantitative easing has been ineffectual and has now largely run its course.
Many have spoken of a “savings glut.” Others talk of secular stagnation in terms of the “natural rate of interest” having moved into very low or negative range which in their theoretical framework means the tendency to save falls short of the tendencies to invest. The obvious response to an excess of savings over investment is to run a corresponding budget deficit which enables the savings to be realised and supports aggregate demand. Some, such as Germany and the Netherlands are able to combine high savings with low investment through a current account surplus, but others need a budget deficit.
In the early days of the great recession there was some mild stimulus and the automatic stabilisers were allowed to operate. But for the past five years the obsession has been on “fiscal consolidation.” Constraints have been placed on fiscal policy, notably in Europe’s Economic and Monetary Union (EMU) but elsewhere, with rules on balanced budget playing a key role in the “fiscal compact” signed by almost all EU countries (and the UK has adopted a similar rule). In practice, and in part because of the lack of growth, balanced budgets have not been achieved. For example, the UK government promised in 2010 the elimination of budget deficit by 2016, but the deficit remains at around 4 per cent of GDP. Most countries of EMU continue to have substantial budget deficits despite the “fiscal compact.” Any notions of “expansionary fiscal consolidation” should now be firmly dismissed.
The IMF (2016) in their World Economic Outlook 2016 notes that the “growth rate of potential output … has declined in major advanced economies” (p. 1). But then argue that “the continued weakness of growth and shrinking macroeconomic policy space, especially in several euro area countries and in Japan, have led policymakers to emphasize structural reforms. The hope is that such reforms will lift potential output over the medium term while also strengthening aggregate demand in the near term by raising consumer and business confidence” (p. 1). The structural reforms that are then listed include deregulating of retail trade, professional services and parts of network industries, “increasing the ability of and incentives for the non-employed to find jobs” (which are in short supply!), lowering the costs of hiring and firing, improve collective bargaining frameworks in instances in which they have struggled to deliver high and stable employment, boost labour market participation and cut the “tax wedge” between labour costs and take-home pay.
These claims echo those used at the time by the EMU, the “fiscal compact,” along with structural reforms, which are those of deregulation and so-called liberalisation; these are supposed to somehow stimulate demand as well as supply potential. In a previous blog post (January 2014), we argued that the evidence does not support any proposition that deregulated labour markets are good for employment and productivity. It is interesting to note that these structural reforms are supposed to raise the growth rate of potential output, but without any mention of research and development, innovation and the use of technical progress—and no mention of ensuring a highly skilled and committed labour force.
The “confidence fairy” is invoked to stimulate aggregate demand, though how making it easier to fire workers is intended to raise consumer confidence is puzzling. A more straightforward way to raise consumer confidence and expenditure would be to raise wages, minimum and low wages in particular, and to avoid depressing aggregate demand by reduction in pensions. There is little reason to think that deregulation will raise aggregate demand, and reasons to think that as it tends to depress wages and to reduce incentives to invest it will have the opposite effects.
A time when interest rates are close to zero and when there is preciously little sign of revival of bank lending and of investment is surely precisely the time for fiscal expansion. Fiscal consolidation and quantitative easing have been tried and have not worked. Public investment has a central role to play here reversing the tendencies to cut back on investment in infrastructure which is showing up now in the poor state of infrastructure in many industrialised countries. Public investment also serves to provide a stimulus for private investment – and to bring a revival of “animal spirits” (and perhaps the “confidence fairy”!). A case of a win-win situation where public investment can be used to address environmental and climate change concerns, and provide employment.
IMF (2016), “Time for a Supply-Side Boost? Macroeconomic Effects of Labour and Product Market Reforms in Advanced Economies”, World Economic Outlook, Chapter 3. International Monetary Fund: Washington.
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