Almost six years since the global financial crisis reached its
height, it's easy to forget just how close to the brink the world
economy came. To someone like Reserve Bank governor Glenn Stevens,
however, those events are burnt on his brain.
Which explains why he thought them worth recalling in a
speech this week. And also why, so many years later, the major developed
economies of the North Atlantic are still so weak and showing little
sign of returning to normal growth any time soon.
When those key decision-makers who lived through 2008 and
2009 say that there was the potential for an outcome every bit as
disastrous as the Great Depression of the 1930s, "I don't think that is
an exaggeration", he says.
"Any account of the events of September and October 2008
reminds one of what an extraordinary couple of months they were.
Virtually every day would bring news of major financial institutions in
distress, markets gyrating wildly or closing altogether, rapid
international spillovers and public interventions on an unprecedented
scale in an attempt to stabilise the situation.
"It was a global panic. The accounts of some of the key
decision-makers that have been published give even more sense of how
desperately close to the edge they thought the system came and how
difficult the task was of stopping it going over."
But, despite the inevitable "mistakes and misjudgments", the
authorities did stop it going over. Stevens attributes this to their
having learnt the lessons of the monumental mistakes and misjudgments
that that turned the Great (sharemarket) Crash of 1929 into the Great
Depression.
Economic historians (including one Ben Bernanke) spent
decades studying the Depression and, in Stevens' summation, they came up
with five key lessons: be prepared to add liquidity – if necessary, a
lot of it – to financial systems that are under stress; don't let bank
failures and a massive credit crunch reinforce a contraction in economic
activity that is already occurring – try to break that feedback loop;
be prepared to use macro-economic policy aggressively.
So far as possible, maintain dialogue and co-operation
between countries and keep markets open, meaning don't resort to trade
protectionism or "beggar-thy-neighbour" exchange rate policies. And act
in ways that promote confidence – have a plan.
There was a lot of action and a lot of international
co-operation, and it worked. As a result, we talk about the Great
Recession, not the Great Depression Mark II.
"We may not like the politics or the optics of it all – all
the 'bailouts', the sense that some people who behaved irresponsibly got
away with it, the recriminations, the second-guessing after the event
and so on," he says. "But the alternative was worse."
With collapse averted, the next step was to fix the broken
banks. Their bad debts had to be written off and their share capital
replenished, either by them raising capital from the markets or
accepting it from the government.
Fixing the banks' balance sheets was necessary for recovery,
but not sufficient. A sound financial system isn't the initiating force
for growth, so stimulatory macro-economic policies were needed to get
things moving.
On top of all the government spending to recapitalise the
banks came a huge amount fiscal (budgetary) stimulus spending. Stevens
says a financial crisis and a deep recession can easily add 20 or 30
percentage points to the ratio of public debt to gross domestic product.
Then you've got the weak economic growth leading to far
weaker than normal levels of tax collections. Add to all that the
various North Atlantic economies that had been running annual budget
deficits for years before the crisis happened.
"So fiscal policy has not had as much scope to continue
supporting recovery as might have been hoped," Stevens says.
"Policymakers in some instances have felt they had little choice but to
move into consolidation mode [spending cuts and tax increases] early in
the recovery."
He doesn't say, but I will: this crazy, counterproductive policy of "austerity" has helped to prolong the agony.
With fiscal policy judged to have used up its scope for
stimulus, that leaves monetary policy. Central banks cut short-term
interest rates hard, but were prevented from doing more because they
soon hit the "zero lower bound" (you can't go lower than 0 per cent).
But long-term interest rates were still well above zero and,
in the US and the euro area, long-term rates play a more central role in
the economy than they do in Oz. Hence the resort to "quantitative
easing".
Under QE, the central bank buys long-term government bonds or
even private bonds and pays for them merely by crediting the accounts
of the banks it bought from. Adding to the demand for bonds forces their
price up and yield (interest rate) down. And reducing long-term rates
is intended to stimulate borrowing and spending.
Has it worked? It's intended to encourage risk-taking, but
are these risks taken by genuine entrepreneurs producing in the real
economy, or are they financial risk-taking through such devices as
increased leverage?
Stevens' judgment is that it always takes time for an economy
to heal after a financial crisis [because it takes so long for banks,
businesses and households to get their balance sheets back in order
- they've borrowed heavily to buy assets now worth much less than they
paid] so it's too soon to draw strong conclusions.
For Stevens, the lesson is that there are limits to how much
monetary policy can do to get economies back to healthy growth after
financial crises. "If people simply don't wish to take on new business risks, monetary policy can't make them," he says.
Perhaps the answer is simply subdued "animal spirits" – low
levels of confidence, he thinks. But, at some stage, sharemarket
analysts and the investor community will ask fewer questions about risk
reduction and more about the company's growth strategy.
