In my previous column I promised that I would present ideas on how to normalise the economy in a somewhat orderly fashion. That is quite a tall order, for a column, but a promise is a promise. So, four options for getting the economy back on its feet. But let me start with two important observations: no single solution will be painless, and it's really urgent that we do something.
No pain, no gain
Before the economy has returned to normal and been made future proof, we will inevitably have to suffer some pain. And that is of course the reason why it is so incredibly difficult to change our economic system. The short-term losses are simply too great, and the long-term gains too abstract, especially for those who call the shots: the people and countries who have the largest amounts of wealth. And that does not mean just the ‘top 1%’ in the US: in a country such as the Netherlands that also includes house owners and people who have accumulated pension rights. That means most of us.
So there will always be people who lose. That is why we should not talk about a ‘soft landing’, but about helping our economy get back on its feet. How can monetary policies be normalized and progress be achieved in a way that benefits everyone? And how can we do that in a way that tackles the major challenges of our time, first and foremost climate change? That is only possible with radical therapy.
This is definitely not the way
Before I present my thoughts on what should happen, let's first briefly look at how we must not go about it. Because these are in fact the approaches that many policy makers are actually taking:
The clear favourite of many: Aiming for undefined economic growth. Economic growth, or rather increased economic activity, is only a good thing if it is productive. By that I mean that it should not only result in more jobs, but especially that it should bring progress or wealth. That could literally be anything: a new type of hair curling iron, a new drug, energy efficient air conditioning, more money for fighting fires in the Amazon region or more money for education. Economic growth that only results in property bubbles and financialization or, worse, economic growth that further breaches ecological limits, for instance exploration of the north pole or forestry (i.e. logging) in the Amazon region, is what we need to get away from.
In second place: Sticking to central banks’ inflation targets. As long as central banks hang on to the idea that inflation must go up, there will always be an argument for further easing of monetary policies - with all the attendant consequences, except accelerating inflation. What will happen is that prices of all financial assets increase: from house prices to equity prices. The whole system is disrupted and becomes unstable. Let central banks please get on with what they were created for: monitor and promote price stability and financial stability.
In third place: Economic policy aimed at safeguarding existing interests. Implicitly, that is what is currently going on. Due to the extremely low level of interest rates, even not very productive companies can continue to exist. In a normal economy they would have gone bankrupt ages ago. Secondly, there is no incentive for private parties to reduce their loans. In a normal economy they would. Finally, and also because of the virtually non-existent risk perception, there is also little incentive for governments to reform. Normally, there would be. You can keep calling for economic reforms, but the absence of financial stimuli far from encourages that.
Potential, uneasy solutions
The solutions for getting the economy back on its feet are complicated enough from an economic perspective but are even more tricky from a political point of view. Because no policy maker wants to be responsible for short-term losses suffered by the richest members of society. Paul Volcker, chairman of the US Fed in the early 1980's, was the last one who dared to stick his neck out in this respect, by raising interest rates at the beginning of the decade.
In my view there are a few options, that will often have to be deployed in combination, but all of them will cause pain.
Option 1:Monetary shock therapy; tightening instead of further easing. Interest rates must not be cut any further, but should be raised sharply, in one fell swoop. Is that possible? Yes, just about. Is the timing right? No. This has been postponed for far too long and the economic cycle is nearing its end worldwide. Are the consequences what we want? Partly, because debt positions are becoming unsustainable and must be reduced. But partly they are not, because high interest rates slow down economic activity, lead to bankruptcies and debts that cannot be paid off and can cause sharp drops in asset values. Only raising interest rates will therefore not result in a more effective economy and may instead, in a worst-case scenario, cause the whole economy to grind to a halt.
Option 2:Budgetary shock therapy; governments enter the arena to give the economy a boost. Against the background of the low level of interest rates, it is very attractive from a social point of view to invest large sums of money in public assets. And that could normalise the economy, because one of the reasons why interest rates are so low is the global lack of capital investment demand. Government investments in greening the economy, for instance, or large investments in knowledge and education produce sizeable social returns and lead to innovation. Such investments will, however, need to be made on a much larger scale than is currently being considered. Otherwise the ‘Japan effect’ will occur; time and again, growth will pick up slightly, only to be followed by a relapse, while government debt will continue to grow without any prospect of a structural improvement. This can only be resolved by implementing a convincing large plan on a global or at least European scale. However, existing budget rules and debt positions present quite an obstacle for the implementation of this option and in Europe must therefore be set aside in a sensible manner. And by sensible I mean that expenditure must not be used for short-term consumption but for investments with a long horizon.
Option 3:Debt shock therapy. A ‘debt jubilee’ or debt cancellation is a very old concept. Thousands of years ago, the Mesopotamians cancelled (household) debt once every so often. In a less distant past, just after World War II, the US cancelled the debts of its European allies. The underlying idea is that if everyone is always made to fulfil their debt obligations, this can paralyse the economic process. That is certainly the case when debt has not been used productively; it can take a very long time before such debt is paid back.
The economic advantage of cancelling debt is obvious; governments and companies can then scale up their investments and increase their innovation efforts again and monetary policy can return to normal. A debt jubilee is a mainly a difficult choice for political reasons, however, partly because it entails all sorts of legal issues. And also: one party's debt is, of course, another party's asset.
Option 4:Free money. This can also be considered a form of debt shock therapy. Monetary funding, or helicopter money, has the advantage of allowing debt to be paid off without having to cancel any debt. This can give the economy a new kick start. Depending on the exact form of the easing measure, redistribution may be made possible and possibly certain projects, sustainability projects for instance, may be funded. Targeted monetary easing works much better than the untargeted liquidity howitzer that is constantly being deployed now. There are of course undesirable side effects, such as inflation spiralling out of control. But that is still a long way off and if it should occur, central banks could still deploy the usual monetary instruments that they have in their conventional toolboxes.
This appears to be a reasonable selection of options to choose from. But clearly, most policy makers do not consider any of these four options an option at all. Ultimately, however, there is no other way out for them. We must make choices, because the economy cannot remain standing on its head indefinitely.
Also read Hans' column 'Time for the big renovation', in which he argues that we must not be content with merely reducing the collateral damage of our current system. Instead, we must pave the way for a truly feasible long-term value model that initiates the shift towards a sustainable, circular and inclusive society.
Serving as a catalyst in the transition to a balanced economy, Triodos Investment Management invests only in companies that contribute to a sustainable society through their products, services, and business practices. Download our whitepaper ‘Impact investing through listed equities and bonds’ and find out how we do this through our investments in listed equities and bonds.