Across the North Atlantic region, central bankers and governments seem, for the most part, helpless to restore full employment to their economies. Europe has slipped back into recession without ever really recovering from the financial/sovereign-debt crisis that began in 2008. The US economy is currently growing at 1.5 percent per year (about a full percentage point less than potential), and growth may slow, owing to a small fiscal contraction this year.
Industrial market economies have been suffering from periodic financial crises, followed by high unemployment, at least since the Panic of 1825 nearly caused the Bank of England to collapse. Such episodes are bad for everybody — workers who lose their jobs, entrepreneurs and equity holders who lose their profits, governments that lose their tax revenue and bondholders who suffer the consequences of bankruptcy — and we have had nearly two centuries to figure out how to deal with them. So why have governments and central banks failed?
There are three reasons why the authorities might fail to restore full employment rapidly after a downturn. For starters, unanchored inflation expectations and structural difficulties might mean that efforts to boost demand show up almost entirely in faster price growth and only minimally in higher employment. That was the problem in the 1970s, but it is not the problem now.
The second reason might be that even with anchored inflation expectations (and thus price stability), policymakers do not know how to keep them anchored while boosting the flow of spending in the economy.
And here one stops, flummoxed. By 1829, Western Europe’s technocratic economists had figured out why these periodic grand mal economic seizures occurred. That year, Jean-Baptiste Say published his Cours Complet d’Economie Politique Pratique, admitting that Thomas Malthus had been at least half right in arguing that an economy could suffer for years from a “general glut” of commodities, with nearly everybody trying to reduce spending below income — in today’s jargon, to deleverage. And, because one person’s spending is another’s income, universal deleveraging produces only depression and high unemployment.
Over the following century, economists like John Stuart Mill, Walter Bagehot, Irving Fisher, Knut Wicksell and John Maynard Keynes devised a list of steps to take to avoid or cure a depression.
One, do not go there in the first place: Avoid whatever it is — whether external pressure under the gold standard, asset-price bubbles or leverage-and-panic cycles, such as that of 2003-2009 — that creates the desire to deleverage.
Two, if you do find yourself there, stop the desire to deleverage by having the central bank buy bonds for cash, thereby pushing down interest rates, so that holding debt becomes more attractive than holding cash.
Three, if you still find yourself there, stop the desire to deleverage by having the Treasury guarantee risky assets, or issue safe ones, to raise the quality of debt in the market; this, too, will make holding debt more attractive.
Four, if that fails, stop the desire to deleverage by promising to print more money in the future, which would raise the rate of inflation and make holding cash less attractive than spending it.
Five, in the worst case, have the government step in, borrow money and buy stuff, thereby rebalancing the economy as the private sector deleverages.