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Wednesday, September 29, 2010
Adam Posen, of the Bank of England's external monetary policy committee, is now convinced that the Bank needs to act fast to avoid a prolonged period of Japanese-style economic stagnation. He argues that the accumulating evidence suggests that the downside risk to doing nothing far outweighs the risks of inflation.
When the overwhelming bulk of pressures in the economy are disinflationary, and when the level of output and employment is clearly likely to be below potential for an extended period, it is right for central bankers to take the additional negative effects of protracted recession on trend productivity growth and on capacity into account.
Is Posen right? I haven't a clue. But he does raise one point which I think is worth noting: there's more at stake here than simply a bit of lost productivity growth and economic capacity:
Let us not forget that it was sustained high unemployment and austerity, the sense that governments were unresponsive to average people’s dire economic conditions, which led to the rise of extremist intolerant parties in pre-war Europe
Thankfully, some of the worst predictions have not come to pass. But the danger has not disappeared; a casual scan of the recent news reveals as much. The US has its own backlash in the form of the surging Tea Party movement. The British Labour Party just recently elected Ed Milliband as their leader, indicating a sharp tack to the left. In both cases, these shifts are likely to be politically counter-productive. But in both cases, I read this as a giant "Fuck You" to the ruling consensus that has dominated Anlgo-American policymaking since the late 1990s.
Granted, prolonged recessions do not necessarily result in deep social unrest. From my (limited) knowlege of Japan, it does not appear that over a decade of economic stagnation has resulted in major upheavals in society. I suspect that this has much to do with the structure and characteristics of Japanese society, however. And it should be pretty clear by now that Europe is definitely not Japan.To borrow the text from Rory's post last year:
"This poses obvious risks to political stability and commerce. It also constrains the options available to policymakers, making beggar-thy-neighbor actions such as the imposition of trade barriers, subsidization or nationalization of industries and currency devaluation more likely. History tells us that these domestic political considerations, particularly in the developing world, risk reinforcing the downward economic spiral, as policymakers appease factions and fail to reach coordinated regional/global programs. They also risk, particularly in the case of currency devaluations, setting off a [chain] reaction of competitive responses that, in the absence of regional cooperation, ultimately destabilizes the system as a whole."So it's clear that while inaction is not an option, the kind of response that the political leadership provide matters even more. The G20 proved to be surprisingly successful in coordinating a strong response to the crisis itself, but that level of cooperation is starting to fade in the aftermath as leaders re-focus domestic priorities. The recent signs of a looming "currency war" are a worrisome case in point.
What we may be facing, then, is a prolonged period of discontent. The only solution is to avoid political posturing and short-termism and take the necessary steps to restore healthy economic growth. These steps may end up being painful or risky but, as Posen rightly points out, the downside risk to doing nothing at all is far too high.
(photo: Reuters)
