Rediscovering Growth. Andrew Sentance
easing in the United States and the United Kingdom have not worked. The US Federal Reserve launched its ‘QE2’ policy in late 2010 and continued it through the first half of 2011. But this did not prevent the US growth rate slowing down to below 2% per annum in 2011. A further round of asset purchases which started in mid-2012 – ‘QE3’ – also appears to have had a limited effect on economic growth rates. In the same way, additional injections of quantitative easing by the Bank of England in late 2011 and 2012 did not prevent the economy slowing to almost a standstill over that period.
Some argue that the outcomes in the United States and the United Kingdom would have been even worse without these injections of additional money or that lags in the system have delayed their impact. I would dispute these arguments. But, in any case, these continuing programmes of central bank stimulus have clearly not been able to restore the growth rate back to its pre-crisis trend. This is in line with the consensus view of economists since the 1980s that monetary policy is best suited to ironing out short-term fluctuations in the economy and does not have the potential to influence growth trends over longer periods. Longer-term growth reflects deeper fundamentals relating to the capabilities of our economies – the capacity of businesses to innovate and develop new products and processes, their confidence in investing in new facilities, the skills of the workers they employ, and their ability to provide the goods and services which the public demand.
The reality: It’s the New Normal
A common theme underpinning these myths and misperceptions about our problem of slow growth in the West is that there is an external force holding our economies back. So if only that dampening influence could be removed, growth could bounce back to the rates we enjoyed before the crisis. In other words, if the world economy picked up, if the government abandoned austerity, or if central banks were able to do more – everything would be all right.
But that is not the case – which is now being more widely recognized. The forces shaping our New Normal of disappointing growth in the Western world are more deeply rooted within our economies and cannot be relieved easily. As a result, we need to be more willing to adapt to our current situation and take a longer-term view of how we might improve economic prospects. But before we turn to a more in-depth analysis of our New Normal economy, it makes sense to consider the lessons of history.
In the words of the Spanish philosopher George Santayana: ‘Those who cannot remember the past are condemned to repeat it.’ So the next chapter considers what we can learn from the two previous episodes when we have seen serious financial and economic turmoil in the major Western economies and a big dislocation of growth: the 1930s and the 1970s.
Chapter 2
Lessons from the past
Before 2008, there were only two previous years in modern peacetime history which saw such a dramatic turning point in the world economy: 1930 and 1974. Both years ushered in a prolonged period of disappointing economic growth, high unemployment and turbulence across the major economies of the Western world. What lessons can we draw from these previous episodes?
In responding to the recent financial crisis, policymakers and commentators have tended to draw more heavily on the experience of the 1930s than the 1970s. Ben Bernanke, the outgoing Chairman of the US Federal Reserve, studied the 1930s’ experience as an academic. In a speech in April 2010,11 he highlighted four key lessons from that period:
First, economic prosperity depends on financial stability; second, policymakers must respond forcefully, creatively, and decisively to severe financial crises; third, crises that are international in scope require an international response; and fourth, unfortunately, history is never a perfect guide.
The former Governor of the Bank of England, Mervyn King, was an academic colleague of Bernanke’s in the United States in the early 1980s. In a speech thirty years later,12 he referred back to that experience in highlighting the lessons he drew from the experience of the 1930s:
Thirty years ago Ben Bernanke and I had adjoining offices at MIT. We never imagined that thirty years later we would be colleagues as central bank governors, and even if we had, we would never have believed that the industrialised world would have faced an economic and financial crisis on a par with the problems seen in the 1930s… The worst problems of the 1930s were avoided this time around because of the stimulatory policies injected into the world economy by central banks and governments around the world although it is fair to say that a recovery of a durable kind is proving elusive.
Lessons from the 1930s
The analysis of the Great Depression by Bernanke and others – building on earlier research by Milton Friedman and Anna Schwartz13 – highlighted the importance of a large monetary contraction as a key factor triggering the depression of the 1930s. This monetary squeeze was aggravated by the efforts of countries to stay on the Gold Standard, which locked them into a deflationary downward spiral. In 1931, Britain and a number of other countries abandoned the link to gold, but it was not until the beginning of 1934 that the United States devalued the dollar relative to the gold price. By that time its unemployment rate had already risen to over 20%. Meanwhile US GDP fell by nearly 30% in real terms between 1929 and 1933, and the level of prices dropped by around a quarter over the same period. The rise in unemployment and the fall in output and prices were much less pronounced in countries like the United Kingdom which had abandoned the Gold Standard more quickly.
The key driving force behind the policy measures taken around the world in late 2008 and 2009 was to avoid a repeat of this dismal record of economic failure. And this was successfully achieved. Although GDP fell and unemployment rose, the very severe distress of the 1930s was avoided. As Figure 2.1 shows, the levels of unemployment experienced in the United States, United Kingdom and Europe were much closer to the experience of previous post-war recessions – in the 1980s and 1990s – than they were to the 1930s.
Figure 2.1. Post-recession unemployment rates. Source: IMF from 1980; various historical studies for 1930s.
Other problems which had contributed to the severity of the depression in the 1930s were also avoided following the recent financial crisis. Deflation has not emerged as a serious phenomenon. As we noted in Chapter 1, inflation has been a bigger problem since the financial crisis than falling prices – particularly in emerging market economies. Fiscal policies have also been more flexible. When the recession hit in 2008–9, governments were prepared to allow their deficits to rise for a while and incur extra borrowing to support demand – heeding the policy advice from John Maynard Keynes in the 1930s. It is only as growth has resumed that Western governments have focused more actively on deficit and debt reduction.
Another important difference from the 1930s is that we have seen a stronger focus on international economic policy cooperation, which was particularly noticeable in the depths of the crisis in 2008 and 2009. The G20 – which includes leading emerging markets and developing economies as well as the major Western powers – has become an important forum for discussion of international economic policy issues. The G20 Summit in London in April 2009 provided a strong commitment to use expansionary monetary policies across the world to support demand and to avoid protectionism, even though there were differences of view and emphasis between governments on how far extra public spending and borrowing should be used to support demand.
Perhaps most important of all, the world has avoided a serious lapse into protectionism, which greatly aggravated the length and depth of the Great Depression. The US Tariff Act, which was signed into law in June 1930, prompted a worldwide surge in protectionist measures as other countries retaliated to restrictions on their exports. World trade fell between 1929 and 1933 by nearly 30% and trade volumes did not recover their pre-recession level until after World War II.14
By contrast, though world trade was hit by recession in 2008–9, it soon bounced back. Trade volumes dropped by more than 10% in 2009, but that decline was more than recouped in 2010 and world trade in 2013 is, at the time of writing, estimated to be 13% above its pre-recession peak in 2008.