Now comes the hard part of sav­ing economies

The Pak Banker - - OPINION - Joseph E. Stiglitz

SEVEN years af­ter the global fi­nan­cial cri­sis erupted in 2008, the world econ­omy con­tin­ued to stum­ble in 2015. Ac­cord­ing to the United Na­tions' re­port 'World Eco­nomic Sit­u­a­tion and Prospects 2016', the av­er­age growth rate in de­vel­oped economies has de­clined by more than 54 per cent since the cri­sis. An es­ti­mated 44 mil­lion peo­ple are un­em­ployed in de­vel­oped coun­tries, about 12 mil­lion more than in 2007, while in­fla­tion has reached its low­est level since the cri­sis. More wor­ry­ingly, ad­vanced coun­tries' growth rates have also be­come more volatile. This is sur­pris­ing, be­cause, as de­vel­oped economies with fully open cap­i­tal ac­counts, they should have ben­e­fited from the free flow of cap­i­tal and in­ter­na­tional risk shar­ing - and thus ex­pe­ri­enced lit­tle macroe­co­nomic volatil­ity. Fur­ther­more, so­cial trans­fers, in­clud­ing un­em­ploy­ment ben­e­fits, should have al­lowed house­holds to sta­bilise their con­sump­tion.

But the dom­i­nant poli­cies dur­ing the post-cri­sis pe­riod - fis­cal re­trench­ment and quan­ti­ta­tive eas­ing (QE) by ma­jor cen­tral banks - have of­fered lit­tle sup­port to stim­u­late house­hold con­sump­tion, in­vest­ment, and growth. On the con­trary, they have tended to make mat­ters worse. In the US, quan­ti­ta­tive eas­ing did not boost con­sump­tion and in­vest­ment partly be­cause most of the ad­di­tional liq­uid­ity re­turned to cen­tral banks' cof­fers in the form of ex­cess re­serves. The Fi­nan­cial Ser­vices Reg­u­la­tory Re­lief Act of 2006, which au­tho­rised the Fed­eral Re­serve to pay in­ter­est on re­quired and ex­cess re­serves, thus un­der­mined the key ob­jec­tive of QE. In­deed, with the US fi­nan­cial sec­tor on the brink of col­lapse, the Emer­gency Eco­nomic Sta­bi­liza­tion Act of 2008 moved up the ef­fec­tive date for of­fer­ing in­ter­est on re­serves by three years, to Oc­to­ber 1, 2008. As a re­sult, ex­cess re­serves held at the Fed soared, from an av­er­age of $200 bil­lion dur­ing 2000-08 to $1.6 tril­lion dur­ing 2009-15. Fi­nan­cial in­sti­tu­tions chose to keep their money with the Fed in­stead of lend­ing to the real econ­omy, earn­ing nearly $30 bil­lion - com­pletely risk-free - dur­ing the last five years. This amounts to a gen­er­ous - and largely hid­den - sub­sidy from the Fed to the fi­nan­cial sec­tor. And, as a con­se­quence of the Fed's in­ter­est-rate hike last month, the sub­sidy will in­crease by $13 bil­lion this year. Per­verse in­cen­tives are only one rea­son that many of the hoped-for ben­e­fits of low in­ter­est rates did not ma­te­ri­alise. Given that QE man­aged to sus­tain near-zero in­ter­est rates for al­most seven years, it should have en­cour­aged gov­ern­ments in de­vel­oped coun­tries to bor­row and in­vest in in­fra­struc­ture, education, and so­cial sec­tors. In­creas­ing so­cial trans­fers dur­ing the post-cri­sis pe­riod would have boosted ag­gre­gate de­mand and smoothed out con­sump­tion pat­terns.

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