This book rather continues the theme of past and present financial crises. If anything, it belongs in the category of 'financial crises soon to come'. It has been interesting to chart how financial crises arise (the Overends Crisis of 1866) and how a policy response was framed (the financial crisis of 1914). It is disturbing to see that the conditions of 1866 are not that very different to those today, and our policy response is quite timid compared to that of 1914.
The book starts by considering two shortcomings of conventional macroeconomics - the belief in the exogeneity of the money supply and the consequent setting aside of the financial sector. This provides the starting point for the book. The author demonstrates how credit conditions have a multiplier effect within the financial sector. This makes the money supply endogenous to the system, and not exogenous, as is currently assumed by the mainstream.
If we take that insight, we can derive some interesting conclusions from it. For example, one that stayed with me the most is that, if we move from the monetary economy to the real economy, purchasing power can be seen as aggregate demand plus credit growth. This helps to explain the recent bout of debt fuelled growth in China, which has been a bit of a puzzle. It also helps to explain the observation that households have been maintaining their living standards in the face of falling real incomes by taking on more debt. Our recent growth has not been propelled by growth in our productive capacity. It has been propelled by the growth in total credit within the economy.
This works fine until credit growth stops. One of the reasons why it stops is that lenders become wary about the ability of the borrowers to repay and service their loans. If credit growth just falters - a stumble rather than a fall - then the multiplier effect works in the reverse direction. Credit then becomes scarce and operational conditions in the real economy become tighter. A downturn begins. Conventional economics says that this downturn couldn't happen, which is probably why conventional economics was blind-sided by the crash of 2007.
The policy prescriptions in this case are quite clear. There is a case for the government to make up any reductions in aggregate demand through a programme of spending. Spending on investment is better, but spending on the current account will do just as well. This will help to shore up credit and help to counter the downward multiplier.
Since 2010, we have seen the exact opposite of this. Whereas trading conditions have called for a fiscal expansion, we have actually been on the receiving end of a fiscal contraction - austerity. The role of a fiscal expansion is to inject liquidity into the monetary system, as well as demand into the real economy to mop up that additional liquidity. A monetary expansion through QE serves to inject liquidity into the monetary system. Without the corresponding fiscal expansion, that monetary injection only serves to pump up asset bubbles, in our case in the stock markets and property markets. These then have the side effect of growing inequality.
It is at this point that we get to see the answer in the title. Pumped up asset bubbles have not gone any way to resolve the disruption of the credit system. We still have the global financial imbalances that gave rise to the growth of credit to begin with. This suggests that it is a matter of time before we experience another financial crisis, except that, this time around, the monetary authorities have far fewer policy tools through which they can address it.
A heavy dose of inflation would help to resolve the matter, but politics tends to get in the way here. Inflation tends to redistribute income shares from the 'haves' to the 'have nots', and the current political structure is not geared to achieve this. It is for this reason we can expect that future economic turbulence may be closely associated with political turbulence. One feels that the political pressure is rising as further austerity fails to resolve the crash of 2007.
This is a very short book, but it is very deep. It is surprisingly easy to read for an economics polemic. The author understands what he is saying, and sets it out in a very clear, logical, and methodical way. Prior familiarity with economics would be useful in reading the book, but a lay person acquainted with current affairs ought not to find it too much of a struggle. I found it to be a very useful text.
The book starts by considering two shortcomings of conventional macroeconomics - the belief in the exogeneity of the money supply and the consequent setting aside of the financial sector. This provides the starting point for the book. The author demonstrates how credit conditions have a multiplier effect within the financial sector. This makes the money supply endogenous to the system, and not exogenous, as is currently assumed by the mainstream.
If we take that insight, we can derive some interesting conclusions from it. For example, one that stayed with me the most is that, if we move from the monetary economy to the real economy, purchasing power can be seen as aggregate demand plus credit growth. This helps to explain the recent bout of debt fuelled growth in China, which has been a bit of a puzzle. It also helps to explain the observation that households have been maintaining their living standards in the face of falling real incomes by taking on more debt. Our recent growth has not been propelled by growth in our productive capacity. It has been propelled by the growth in total credit within the economy.
This works fine until credit growth stops. One of the reasons why it stops is that lenders become wary about the ability of the borrowers to repay and service their loans. If credit growth just falters - a stumble rather than a fall - then the multiplier effect works in the reverse direction. Credit then becomes scarce and operational conditions in the real economy become tighter. A downturn begins. Conventional economics says that this downturn couldn't happen, which is probably why conventional economics was blind-sided by the crash of 2007.
The policy prescriptions in this case are quite clear. There is a case for the government to make up any reductions in aggregate demand through a programme of spending. Spending on investment is better, but spending on the current account will do just as well. This will help to shore up credit and help to counter the downward multiplier.
Since 2010, we have seen the exact opposite of this. Whereas trading conditions have called for a fiscal expansion, we have actually been on the receiving end of a fiscal contraction - austerity. The role of a fiscal expansion is to inject liquidity into the monetary system, as well as demand into the real economy to mop up that additional liquidity. A monetary expansion through QE serves to inject liquidity into the monetary system. Without the corresponding fiscal expansion, that monetary injection only serves to pump up asset bubbles, in our case in the stock markets and property markets. These then have the side effect of growing inequality.
It is at this point that we get to see the answer in the title. Pumped up asset bubbles have not gone any way to resolve the disruption of the credit system. We still have the global financial imbalances that gave rise to the growth of credit to begin with. This suggests that it is a matter of time before we experience another financial crisis, except that, this time around, the monetary authorities have far fewer policy tools through which they can address it.
A heavy dose of inflation would help to resolve the matter, but politics tends to get in the way here. Inflation tends to redistribute income shares from the 'haves' to the 'have nots', and the current political structure is not geared to achieve this. It is for this reason we can expect that future economic turbulence may be closely associated with political turbulence. One feels that the political pressure is rising as further austerity fails to resolve the crash of 2007.
This is a very short book, but it is very deep. It is surprisingly easy to read for an economics polemic. The author understands what he is saying, and sets it out in a very clear, logical, and methodical way. Prior familiarity with economics would be useful in reading the book, but a lay person acquainted with current affairs ought not to find it too much of a struggle. I found it to be a very useful text.
Stephen Aguilar-Millan
© The European Futures Observatory 2018
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