10 July 2012

Martin Wolf: We still have that sinking feeling

Far too much policy-making and advice neither recognises the post-crisis challenges nor crafts effective answers, comments Wolf in his FT column. The heart of the matter is accelerating deleveraging, while promoting recovery.

So the big story continues to be one of private sector deleveraging, tempered by easy monetary policy and offset by the leveraging of the government’s balance sheet. The willingness of the authorities to do both of these things, despite foolish criticism, prevented us from experiencing a second great depression and continues to do so. The idea seems fantastic that these large fiscal deficits are crowding out private spending when interest rates are so low in countries blessed by not being in the eurozone.

Yet some official observers are distressed by these policies. In its latest annual report, the Bank for International Settlements apparently argues for monetary and fiscal tightening in high income countries. Yet it presents no comprehensible analysis of the consequences. It remarks, for example, that “fiscal multipliers in a balance sheet recession may be lower than in normal recessions. In particular, in a balance sheet recession, overly indebted agents – these days, households typically – are likely to allocate a higher fraction of each additional unit of income to reducing their debt rather than increasing discretionary spending”. That is indeed possible. The conclusion is that fiscal deficits, readily financed in important countries, need to be still bigger because they must both facilitate deleveraging and sustain demand. The other plausible way to accelerate deleveraging is mass bankruptcy, also known as a depression. Does the BIS want that?

We know that big financial crises cast long shadows, particularly in countries whose underlying rate of growth is modest, which makes deleveraging slow. Policy must both sustain demand and facilitate deleveraging. This means aggressive monetary and fiscal policies, working in combination, along with interventions aimed at recapitalising banks and accelerating restructuring of private debt... Austerity should follow a strong recovery, not precede it.

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