- - Wednesday, September 17, 2014


By Martin Wolf
Penguin, $35, 496 pages

Six years after the global financial crisis, it still remains unclear whether we have the right economic policies to avert the next crisis, let alone the right policies to help an economy currently in “secular stagnation.” The debate around monetary policy has never been more profound, with the House of Representatives now considering passing laws that would legislate a monetary-policy rule similar to the mathematical rule advocated by Stanford economist John B. Taylor.

With central banks, such as the Federal Reserve and the Bank of England, positioning to raise benchmark interest rates in mid-2015 while the European Central Bank is announcing its intentions of engaging in quantitative easing for the first time, the global economy is at a crossroads of countries that may finally be seeing light at the end of the tunnel and those that are just entering it.

Martin Wolf has established himself as one of the most influential economics journalists of our time, which has never been clearer than in his latest book, “The Shifts and The Shocks,” on the anemic global economic recovery since 2008, outlining many of the reasons why economic growth has been so underwhelming since the crisis and what policy reforms he thinks are needed to avert another downturn.

In addressing the causes of the financial crisis, unlike most liberal economic commentators, Mr. Wolf refrains from arguing that the Great Recession was largely a result of financial deregulation, but rather a result of the low-interest rate policies of central banks, such as the Federal Reserve, which helped to fuel credit growth underlying a housing bubble that led to panic in the financial sector and ultimate collapse in the global economy.

Mr. Wolf thinks that the immediate policy response in the United States, led by Ben S. Bernanke, Henry M. Paulson and Timothy F. Geithner, was adequate, but since then was lost in the whims of politics surrounding the Dodd-Frank law, leaving the shadow banking system largely untouched and prone to another crisis without requisite reform.

Mr. Wolf genuinely wants the financial system to move beyond the too-big-to-fail norm of providing bank bailouts on demand, championing capital and leverage requirements, such as those part of the Basel III standards, as an essential part of financial reform.

However, some of Mr. Wolf’s ideas for reform go a bit too far to be considered conventional economics. One idea he proposes is introducing “helicopter money,” which is the funding of government deficits through direct central bank money creation, a radical form of monetary stimulus. Another is the regressive idea of limiting international activity by banks, as Mr. Wolf sees that giving free rein across borders creates systemic risk. He also suggests that some economies may want to experiment with implementing a version of the 1930s “Chicago Plan,” a radically narrow banking model where all bank deposits would be fully guaranteed by the government and where the government would have control of the aggregated credit volume.

With respect to the European economy, Mr. Wolf is highly critical of the German-endorsed austerity policies of higher taxes and reduced government spending as being effective at addressing the high unemployment and weak economic growth brought on by the European sovereign-debt crisis. While seemingly to have proven effective for the United Kingdom’s economy, austerity has not proven so for the rest of Europe, with many countries attempting to renegotiate their deals with the International Monetary Fund following their debt restructurings.

While being a devout Keynesian, Mr. Wolf is pessimistic that the renewed monetary-policy efforts of the European Central Bank will be effective at bringing Europe out of its continued malaise, particularly in the most negatively affected countries of Spain, Italy and Greece, whose governments remain intransigent to serious long-term fiscal reform. He leaves the reader with a gloomy outlook for Europe’s economy as the price of their past policy mistakes of excessive government spending and debt.

Mr. Wolf also chides the governments of emerging economies, such as China’s, for fixing their currencies at artificially low levels, generating huge trade surpluses and accumulating substantial reserves. These are the same policies that helped fuel China’s own housing bubble, which has stalled economic growth in the region in recent years following the bubble’s collapse. Mr. Wolf also sees similar easy-money policy mistakes in India, which have led to double-digit annual inflation rates that are now finally cooling down following the recently implemented tight-money policies of the Reserve Bank of India led by Raghuram Rajan.

Mr. Wolf spares absolutely no one in his criticism and chides the entire academic economics discipline for failing to predict the global financial crisis, save economists such as Charles Kindleberger and Nouriel Roubini. Along the same lines, University of Chicago economist John Cochrane has recently highlighted how the leading New Keynesian macroeconomic model cannot reliably explain the tepid economic-growth rates since the crisis.

However, there is hope for the future of academic economics and the future of economic policy. Economists such as Francis Diebold, John Geanakoplos and Lasse Pedersen have led new academic research efforts to measure the overall level of systemic risk in the financial system on a given date.

With respect to policy, recent research by David Papell of the University of Houston has shown that when a central bank follows a rules-based monetary policy, like the Federal Reserve did in much of the 1980s and ‘90s, it has coincided with good economic performance: low inflation, steady employment and output growth. However, when interest rates are kept lower than such a rules-based approach would imply, as was the case from 2003 to 2005, such an environment can create a housing boom and bust.

Even over the past year, the Federal Reserve has not begun to raise the federal funds rate as the conventional monetary-policy rule — commonly known as the Taylor Rule — would prescribe, potentially furthering the same type of expansion of credit that predated our past recession. As the German philosopher G.W.F. Hegel once said, “What experience and history teach us is that people and governments have never learned anything from history.” Let us hope this is not the case with the Great Recession.

Jon Hartley writes a weekly economics column for Forbes.

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