Now that the global economy has been hit by a pandemic, we're once again seeing the rise of weak monetary policies, writes Professor John Quiggin.
IN THE IMMEDIATE AFTERMATH of the Global Financial Crisis, I started work on a book looking at bad economic ideas that had been, as I thought, finally killed by the crisis. These ideas formed part of a package variously known as neoliberalism, economic rationalism and (my preferred term) market liberalism.
As the book progressed, however, I realised that these ideas were being reanimated in zombie form (a term I borrowed from Paul Krugman, winner of the economics Nobel award, as well as being a columnist for the New York Times). So, the title of my book was changed to ‘Zombie Economics: How Dead Ideas Still Walk Among Us’.
A crucial rule in zombie movies is “double-tap”. That is, it’s not sufficient to kill a zombie idea once — it has to be done at least twice. The COVID-19 pandemic has shown, yet again, how disastrously wrong the ideas of market liberalism have been. I’ve decided to write a series of articles on the zombie apocalypse of ideas we are now facing, focusing on those I looked at in ‘Zombie Economics’.
I’ll start with the Great Moderation. This was the idea that the period beginning in 1985 was one of unparalleled macroeconomic stability that could be expected to endure indefinitely. Even when it was alive, this idea depended on some dubious statistical arguments and a willingness to ignore the crises that afflicted many developing economies in the 1990s. But the Great Moderation was too convenient to cavil at.
Of all the ideas tried to kill, this one seems most self-evidently refuted by the crisis. If double-digit unemployment rates and the deepest recession since the 1930s didn’t constitute an end to moderation, what could have done? Yet academic advocates of the Great Moderation hypothesis such as Olivier Coibion and Yuriy Gorodnichenko stuck to their guns, calling the financial crisis a ‘transitory volatility blip’.
As the drawn-out recovery from the crisis continued and official unemployment rates fell back to pre-crisis levels or lower, the assumptions of the Great Moderation crept back into the thinking of many.
‘...that the Great Moderation never really left. It just took those twenty years of steady earnings growth and treated itself to a two-year vacation.’
This claim was striking in its complacency. The advocates of the Great Moderation, most notably Federal Reserve Chief Ben Bernanke, who popularised the term in a 2004 article, attributed reduced volatility to improvements in monetary policy and sophisticated markets. But the GFC made conventional monetary policy, based on regular adjustments to interest rates, impossible. The U.S. Federal funds rate was reduced to zero and was still at that level in 2016. It reached a peak of just over two per cent in 2019.
Meanwhile, the massive fraudulence of financial markets, revealed by the crisis, was further exposed by a steady series of exotically named scandals: the LIBOR rate-rigging affair, the Panama Papers and the CumEx tax fraud, to name just a few. It was obvious, to anyone who cared to look, that financial markets were not in the business of providing sophisticated tools for managing risk and moderating economic fluctuations. Rather, they specialised in extracting profits from insider trading and helping wealthy individuals and corporations to dodge taxes.
The COVID-19 crisis has rapidly demonstrated, yet again, the weakness of conventional monetary policy and the parasitic role of financial markets. Within weeks of the pandemic’s beginning, those central banks that had raised their interest rates above zero were forced to abandon that stand. It has immediately become obvious, however, that this would not be enough. As in 2008, the only option is massive public spending and bailouts of failing businesses.
The lesson that needs to be learned from this is that, while individual crises may be seen as unpredictable “black swans”, the regular occurrence of crises is not. In the past 100 years, we have seen the Spanish flu, the Great Depression, World War II, the stagflation crisis of the 1970s, the stock market crash of 1987, the emerging market crises of the 1990s, the GFC and now the coronavirus pandemic. With the exception of the the “glorious thirty” years of stability from World War II to the crises of the 1970s, such crises occur once every decade or so. Since their consequences can last up to five years, we spend almost as much time dealing with crises as we do in their absence.
The other striking feature of the pandemic is the uselessness of financial markets. In the years before the GFC, there were confident claims that “prediction markets” would identify emerging pandemics before they took place, enabling a rapid response. In reality, despite ample evidence of the potential for disaster, global stock markets kept rising well into February before crashing and wiping out billions of dollars in savings. And, now that the crisis is upon us, no one has even suggested that financial markets might help us to manage it. Rather, the potential for financial collapse is yet another problem with which governments will have to deal.
The moral of this story is that, in the absence of a strong government, committed to maintaining economic stability and full employment, capitalism is inherently chaotic. It is a system incapable of managing exogenous shocks like pandemics, but entirely capable of producing self-generated disasters like the GFC. The claim that this system has produced a “Great Moderation” is a zombie that needs to be destroyed once and for all.
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