Monetarism’s demise paving the way for a Keynesian revival
With global demand beginning to falter again, the world economy needs an extra boost -- but monetary policy has reached its limits
Economist John Maynard Keynes famously stated “in the long run we are all dead”. It is ironic to consider that the predominance of monetarist thinking by policy leaders in the leading economies for the last four decades might now be coming to an early end.
Monetary targeting and inflation control have been central tenets of governments and central banks since the 1980s, when monetarist policies first began to gain broader acceptance in the major economies. But this now seems out of step, with global growth slipping away, demand for money losing steam and deflation risks abounding.
Monetary policy is fast losing traction. The monetary response to the global financial crisis after 2008 worked for a while, with leading central banks saving the world economy and financial markets from catastrophic collapse with spectacular policy accommodation.
But it was also complementary fiscal responses from governments in the major industrial countries, easing up on budget targets, which also helped avert deeper disaster. Governments’ willingness to bail out distressed banks, take on bad assets and open the floodgates to increased deficit spending helped to turn the tide.
It was a classical Keynesian response to dire economic circumstances. Without it, the subsequent recessions in the US, eurozone and the UK could have led to unparalleled depression, mass unemployment and major political disorder. It only worked because governments like those in the US and UK were prepared to let their budget deficits ramp up as high as 13 per cent and 11 per cent of GDP respectively to beat off the deepening crisis.
Now the world economy needs an extra boost. Global demand is beginning to falter again and inflation is stuck close to zero in many economies, with some headline rates submerged in negative territory. Stability risks are rising.
But monetary policy has reached its limits. Interest rates are at rock bottom and the unprecedented US$7 trillion pumped into the global monetary system since 2008 through quantitative easing seems less potent. The world economy is stuck in what Keynes called a “liquidity trap”, where ultra easy money is failing to boost demand. It has not re-vitalised bank lending or jump-started stronger money supply expansion vital for growth.
Much of the increase in global liquidity since QE began has found its way into banks’ balance sheet rebuilding and into financial markets. Investors have channelled QE’s glut of easy money into stock and bond market rallies. But even this is starting to waver owing to increasing doubts about global growth prospects and rising stability risks.
The much hoped-for resurgence of ‘animal spirits’ in the real economy has not really materialised in terms of sustainable recovery, either in consumer demand or business investment. This is bad news considering a third wave of the global financial crisis is threatening to break, this time from emerging markets.
With risk aversion on the rise in the real economy, the knee-jerk reaction from consumers and business has been less spending, increased saving and lower investment – all detrimental to growth. No amount of ultra-easy money left to its own devices is going to resurrect sustainable recovery and get inflation back towards acceptable target levels. It is time for fresh impetus and government intervention. Extra fiscal stimulus will be needed to bridge the gap in demand.
The International Monetary Fund, a bastion of monetary and anti-inflation stringency in the past, is leading calls for a change in tactics and for an end to austerity policies. In the current climate, the IMF argues that efforts among wealthier nations to shrink their deficits – through tax hikes and spending cuts – is causing greater harm to global growth prospects.
Global policymakers need to put fiscal attrition on the back burner and change tack to pro-growth priorities. Increased capital spending on transport, communications and public infrastructure will promote positive multiplier effects to help lift aggregate demand.
International lending organisations like the European Investment Bank, World Bank, Asian Development Bank among others should be re-capitalised to act as conduits for increased investment funding around the globe to help the recovery process.
There is a crying need for broad-based policies to meet the growing demands of a troubled world economy. In the past, monetarist policies have played a strong role in taming inflation, but the time is ripe for interventionist fiscal initiatives to boost employment and growth.
Policy dogma needs to step aside in favour of pragmatic economic solutions combining the best that monetary and fiscal policies have to offer for better global regeneration.
David Brown is the chief executive of New View Economics