Bad governments matter

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August 28, 2019

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We don’t know whether a marked economic slowdown, or even a recession, is going to hit broad swaths of developed countries. If it does, we are in serious trouble. Since the infamous subprime crisis started in 2017, central banks have been deploying an impressive of arrays of tools. They brought their interest rates to close to zero, in some cases into negative territory. They have printed massive amounts of cash as part of their quantitative easing policies. They have made pledges about what they would do far into the future. These were all bold, untested innovations. There was a serious recession in 2009, but that was it (except in the Eurozone where a public debt crisis erupted in 2010, a by-product of policy mistakes). A much-feared repeat of the Great Depression, which hit in the 1930s in the wake of a similar financial crisis, was averted, a feat that will feature in history books.

 

The dog that did not bark is inaction by governments. Beyond a short-lived effort in 2008, most governments were more than happy to let central banks do the heavy lifting. They were concerned by the size of their public debts. Yet, with the exception of Germany, measured as a proportion of GDP, the debts shot up during the crisis and thereafter, as the figure below shows. Not that governments were trying to help out the central banks, simply that they failed to close their deficits because that would have been unpopular. Germany succeeded because the Germans have been allergic to deficits ever since the dramatic events in the 1920s that led to the rise of Nazism. And also because the huge Chinese appetite for big luxury cars made in Germany has provided a huge boost to the economy. By the way, in these times of anti-corruption drives in China, German car sales have plummeted and Germany is about to face a recession.

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Source: AMECO on line, European Commission

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All this is not just of historical interest, unfortunately. The central banks intended to normalize their crisis-era policies. They planned to raise interest rates and to reabsorb the cash that they had injected. That way, they would be ready to act again in case of need. Tough luck, they did not have the time to do so. If a recession hits now, they just have no ammunitions left, or too little. This time around, the only game in town will be fiscal policies, raising public spending or cutting taxes. Don’t hold your breath, though. The current governments are unlikely to help out their hapless central banks. A small recession could turn into a big and long-lasting one.

 

Of course, the governments will explain their inaction by pointing out to even bigger public debts now than in 2007. It does not matter that it is their fault, or that of their predecessors. They have become accustomed to letting their central banks do the job. The central banks, which now see themselves as true heroes that saved the world, are making the crucial mistake of pretending that they still have enough tools, which they don’t. Their hubris provides the cover that governments need to do nothing.

 

It all seems crazy, and it is. The truth is that most developed countries’ governments seem to have gone nuts. To start with, the slowdown, if it happens, is largely due to policy mistakes. The world does not need a trade war. Brexit is a gratuitous shock created for political expediency. Austerity policies in the EU over 2010-14, now replaced with fiscal policy neutrality, are driven by ideological beliefs, not by existing knowledge. Successive Italian governments have not cleaned the banking system and hardly fixed a malfunctioning economy, which has led to stagnation over two decades. Argentina seems addicted to recurrent crises. The mounting fears of a catastrophic climate change are the result of decades-old government inaction and fear-mongering by legions of well-meaning but blinded NGOs. Facing these challenges, it is nothing short of a miracle that consumers are not yet panicking, which would prompt a recession.

 

Populism explains some of these massive failures. At the same time, most populists do not care much about budget deficits and public debts, mostly for wrong reasons. Once in power, directly or indirectly, they do much harm, who knows, it might be helpful to have them in power in the event of a recession. This is how badly things stand nowadays.