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2017-12-21 13:36:22
Governments skilfully tackled the symptoms, not the underlying disease
TEN years ago this month, America entered the Great Recession . A decade on,
the recession occupies a strange space in public memory. Its toll was clearly
large. America suffered a cumulative loss of output estimated at nearly $4trn,
and its labour markets have yet to recover fully. But the recession was far
less bad than it might have been, thanks to the successful application of
lessons from the Depression. Paradoxically, that success spared governments
from enacting bolder reforms of the sort that might make the Great Recession
the once-a-century event economists thought such calamities should be.
Good crisis response treats its symptoms; the symptoms of a disease, after all,
can kill you. On that score today s policymakers did far better than those of
the 1930s. Government budgets have become a much larger share of the economy,
thanks partly to the rise of the modern social safety net. Consequently, public
borrowing and spending on benefits did far more to stabilise the economy than
they did during the Depression. Policymakers stepped in to prevent the
extraordinary collapse in prices and incomes experienced in the 1930s. They
also kept banking panics from spreading, which would have amplified the pain of
the downturn. Though unpopular, the decision to bail out the financial system
prevented the implosion of the global economy.
But the success of those policies, and the relatively bearable recession that
resulted, allowed governments to avoid more dramatic interventions of the sort
which, after the 1930s, gave the world half a century of (relative) economic
calm. By reducing the need for radical innovation, the speed and efficacy of
the response left the world economy less reformed and so vulnerable to the same
forces that made the crisis possible in the first place.
Several shortcomings stand out. In dealing with the Depression, governments
ultimately discarded the gold standard, the global currency regime that helped
propagate the disaster. Countries on gold sacrificed monetary-policy
independence, and had to respond to a loss of market confidence with an
economy-bashing increase in interest rates, for instance. The system
transmitted distress around the world. When one country acted to build up its
gold reserves, others saw a sudden drain on theirs. The sooner a country left
gold in the 1930s, the sooner its recovery began.
But the international system that facilitated the more recent financial crisis
has been neither abandoned nor reformed. Open capital flows can put countries
at the mercy of sudden swings in market sentiment. To manage this, many
emerging markets accumulate foreign-exchange reserves, which can be drawn on in
crisis. But these reserves add to a global glut of capital which depresses
interest rates and encourages borrowing. Because reserves are so often held in
the form of dollar-denominated bonds, they can destabilise the American
economy. They also heighten the world s exposure to American financial
stumbles. This regime helped turn an American housing bust into a global
crisis, and remains in place now. Although dangerous financial vulnerabilities
in America will take time to build up again, the present financial peace is
likely to be far shorter than the 75 years that separated the Depression and
the Great Recession.
Big short memories
That would be less troubling had the world made itself more robust to future
crises after the last one. In the years after the Depression, sweeping banking
and financial reforms created new regulatory institutions and placed tight
constraints on financial behaviour, which made finance a very boring industry
for most of the next half-century. From the 1980s to the 2000s, those
restrictions were largely undone: banks were given freer rein over the
activities they could engage in and products they could create. The financial
crisis could not have occurred without this liberalisation. Yet in its wake,
the financial sector has been treated relatively gently. Oversight and
disclosure have been improved and capital-adequacy rules toughened (see
previous story). But some of these rules are now being relaxed, at least in
America, and the financial industry s weight in the world economy has scarcely
changed. As a share of American GDP it has actually increased somewhat since
2007.
The stabilisation policies used in the Great Recession were vastly superior to
those of the Depression. But today s governments have done a worse job of
learning from experience than did their forebears. Franklin Roosevelt did not
simply seek to restore growth. Rather he promised reflation in order to make up
the ground lost during the downturn. After the Great Recession, in contrast,
most central banks (the Bank of Japan being a notable exception) were content
to prevent prices falling, and have not actively worked to make up lost output.
As a result, the recovery has been much weaker than in previous cycles,
including the Depression (see chart), and monetary policy has taken longer to
return to normal, leaving economies poorly prepared for the next recession.
Similarly, the Great Recession demonstrated the value of automatic fiscal
stabilisers, but governments failed to seize the opportunity to link tax and
benefits more closely to the business cycle. Indeed, rules that have recently
been adopted, such as Europe s fiscal compact, constrain rather than harness
fiscal policy.
The Depression enabled radical change by discrediting untrammelled capitalism
and the elites who supported it. That had dangerous side-effects: it also
empowered fanatical and dangerous political outsiders. Though financial and
political elites were not spared a populist backlash after the Great Recession,
they have largely kept their seat at the table, blocking the enactment of
bolder reforms. The success of the response to the downturn helped avoid some
of the disasters of the 1930s. But it also left the fundamentals of the system
that produced the crisis unchanged. Ten years on, the hopes of radical reform
are all but dashed. The sad upshot is that the global economy may have the
opportunity to relearn the lessons of the past rather sooner than hoped.
This article appeared in the Finance and economics section of the print edition
under the headline "A lost decade"