We all know how the global economic crisis began. The banks over-lent to the housing market. The subsequent burst of the housing bubble in the United States caused banks to fail, because banking had gone global and the big banks held one another’s bad loans. Banking failure caused a credit crunch. Lending dried up and economies started shrinking.
So governments bailed out banks and economies, producing a sovereign debt crisis. With everyone busy deleveraging, economies failed to recover. Much of the world, especially Europe, but also the slightly less sickly US, remains stuck in a semi-slump.
So how do we escape from this hole? The familiar debate is between austerity and stimulus. “Austerians” believe that only balancing government budgets and shrinking national debts will restore investor confidence. The Keynesians believe that without a large fiscal stimulus – a deliberate temporary increase of the deficit – the European and US economies will remain stuck in recession for years to come.
I am one of those who believe that recovery from the crisis requires fiscal stimulus. I don’t think monetary policy, even unorthodox monetary policy, can do the job. Confidence is too low for commercial banks to create credit on the scale needed to return to full employment and the pre-crisis growth trend, however many hundreds of billions of whatever cash central banks pour into them. We are learning all over again that the central bank cannot create whatever level of credit it wants!
So, like Paul Krugman, Martin Wolf, and others, I would expand fiscal deficits, not try to shrink them. I advocate this for the old-fashioned Keynesian reason that we are suffering from a deficiency of aggregate demand, that the multiplier is positive, and that the most effective way to reduce the private and public debts a year or two down the line is by taking steps to boost growth in national income now.2
But the argument between austerians and Keynesians over how to encourage sustained recovery intersects with another debate. Simply put, what kind of post-recovery economy do we want? This is where economics becomes political economy.
Those who believe that all was fine with the pre-crisis economy except for banks making crazy loans are convinced that preventing such crises in the future requires only banking reform. The new reform orthodoxy is “macro-prudential regulation” of commercial banks by the central bank. Some would go further and either nationalize the banks or break them up. But their horizon of reform is similarly confined to the banking sector, and they rarely ask what caused the banks to behave so badly.
In fact, it is possible to regard excessive bank lending as a symptom of deeper economic flaws. The economist Thomas Palley sees it as a means of offsetting growth in income inequality, with access to cheap credit replacing the broken welfare guarantee of social democracy. So reform requires redistribution of wealth and incomes.
Redistributive measures go quite well with stimulus policies, because they may be expected to increase aggregate demand in the short term (owing to lower-income households’ higher propensity to consume) and minimize the economy’s dependence on debt financing in the long term. Initial damage to the confidence of the business class caused by higher taxes on the wealthy would be balanced by the prospect of higher overall consumption.
Others argue that we should try to rebalance the economy not just from rich to poor, but also from energy-wasting to energy-saving. The premise of the green economic agenda is that we have reached the ecological limits of our current growth model, and that we will need to find ways of living that reduce demands on non-renewable sources of energy.
So stimulus policies should aim to stimulate not just demand per se; they must focus, instead, on stimulating ecologically-friendly demand. For example, greens advocate free municipal transport in major cities. In general, they argue, we need more care, not more cars, so stimulus money should go to health, education, and the protection of the environment.
The truth is that any fiscally-driven recovery policy is bound to have reformist implications. That is why the austerians are so against it, and why even those who accept the theoretical case for a stimulus insist on implementing it through monetary policy alone.
Re-balancing the economy from gas-guzzling to energy-saving – and from private to public consumption – is bound to alter the goal of economic policy. Maximizing GDP growth will no longer be the top priority; rather, it should be something we might want to call “happiness,” or “well-being,” or the “good life.”
The radical case is that the pre-crisis economy crashed not because of preventable mistakes in banking, but because money had become the sole arbiter of value. So we should be energetic in seeking recovery, but not in a way that simply reproduces the structural flaws of the past.
As Dani Rodrik has well put it: “If economics were only about profit maximization, it would be just another name for business administration. It is a social discipline, and society has other means of cost accounting beside market prices.”