When Governments Won’t Govern, Central Banks Must
The global economic crisis that started in 2008 is far from over, and we might not have seen the worst. Still, it’s not too early to think about how our response to the crisis might put the economy on course for the next one.
The defining feature of policy since the Great Recession began has been a fundamental shift in what we ask of elected governments on one side and unelected central banks on the other. Governments have failed, and are still failing, to get fiscal policy right. So, with varying degrees of reluctance, central banks have had to step in with quasi-fiscal measures, such as buying long-term government debt or absorbing risks previously borne by the private sector.
This reassignment of duties is no mere technicality. It’s a momentous and troubling development.
To be clear, central banks have good reason to engage in fiscal policy in today’s extraordinary circumstances. Without the radical moves by the Federal Reserve and the Bank of England, the recessions in the U.S. and the U.K. would have been much worse. As I’ve argued before, avoiding a second and even deeper recession in Europe will probably require the European Central Bank to act with similar force. Central banks are shouldering new responsibilities largely because elected governments abdicated theirs.
The longer-term implications of this reversal, though, aren’t good.
First, an important point of principle. When the Fed and its counterparts do fiscal policy, they undermine the political legitimacy of independent central banking. I’m guessing this is one main reason the Fed has been slow to start a third round of quantitative easing. People are accustomed to thinking of monetary policy as a relatively technical matter, whereas fiscal policy (who gets what, and who pays) is as political as it gets. No central banker wants to cross that boundary, for fear of attracting new scrutiny that would complicate ordinary monetary policy and make it harder to act promptly in the next crisis.
Unorthodox monetary policy has many practical drawbacks, too. In its recent annual report, the Bank for International Settlements, the Basel-based agency that acts as a bank for central banks, notes several. For one, there’s the crucial issue of the exit strategy -- that is, how central banks will eventually unload all the bonds they have purchased in their efforts to stimulate demand. With interest rates already at or close to zero, and with consumers still burdened by heavy debt loads, central banks have to embark on ever-larger rounds of quantitative easing or other unconventional measures to make a difference. That takes them deeper into uncharted territory. Nobody knows how hard it will be to unwind these interventions.
Meanwhile, says the Bank for International Settlements, this huge monetary accommodation might be partly self-defeating. By encouraging people to borrow, it may delay the debt-paring ultimately needed to bring the economy back to health. Easy money masks underlying problems, and lessens the incentive to confront them. Low interest rates, for example, make it cheaper for banks to carry nonperforming loans. Also, when returns on safe investments are low, they encourage investors to take on more risk in their search for better yields. To some extent, that’s exactly what central banks are aiming to achieve. But if it works too well, the pattern of the last decade could repeat itself.
Monetary policy is simply too blunt a tool for many of the jobs for which it’s being used. Debt loads could be reduced much faster if lenders promptly recognized their losses and restructured their bad loans. The U.S. government, by spending some taxpayer money to encourage debt relief, could have done a lot more to break the logjam of foreclosed or about-to-be- foreclosed properties than the Fed’s unorthodox measures have, without putting the Fed’s future operations at risk.
Today’s debate over short-term fiscal stimulus -- and over the merits of austerity -- obscures a larger point. The worst mistakes in fiscal policy were made before the current recession ever began. Too many of the world’s governments acted irresponsibly before their economies slumped. As their economies slowed, automatic and discretionary fiscal stimulus forced debt ratios so high that many countries’ sovereign debt lost its “no- risk” status. In Europe, that made things immeasurably worse. The banks, which held that debt, found themselves in a deeper hole, and many countries had to tighten budgets under duress as their economies shrank.
Here’s the main lesson for the future. Debt ratios need to be brought down to a level that will allow aggressive fiscal easing during the next crisis. To save activist fiscal policy, we need austerity. But with debt ratios as high as they are now, it’s not a question of austerity or stimulus. To cushion economies today, the austerity must be intelligently phased.
The past few years suggest the political systems in the U.S. and Europe aren’t up to such a nuanced task. If that’s true, central banks must fill the void as best as they can. Don’t blame them if the results aren’t thrilling. The alternative is worse.
(Clive Crook is a Bloomberg View columnist. The opinions expressed are his own.)
Today’s highlights: the editors on the panic over Greece; Margaret Carlson on mothers in the workplace; Peter Orszag on why the U.S. Postal Service should be privatized; A. Gary Shilling on how to remake university financing; David Gordon and Sean West on why the U.S. emerging-market moment is over.
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