How do we stimulate the global economy in tackling the next downturn?
There is growing anxiety that policymakers in the developed world will need to consider some radical approaches to tackling the next downturn. Quantitative easing (the buying of government bonds using the money of the central bank) is limited and with interest rates already a record lows a further drop is unlikely to stimulate much more aggregate demand. Fiscal policy could be employed – tax cuts and increases in government spending. However the issue here is how much fiscal stimulus can government’s afford with the debt they already have? See table
Government policy in recent years has done little to improve the economic climate. Although there has been many rounds of quantitative easing the productivity of those in work has been poor leading to lethargic growth levels. This ultimately limits real wage growth and tax revenue to reduce government debt levels. Economies are now doomed to many years of weaker growth with lackluster demand which will mean more radical policies outside the square. Some policy options could be:
Fusing Monetary and Fiscal Policy
An option discussed in The Economist was to finance public spending and the tax cuts by printing more money. This could be more effective than Quantitive Easing (QE) as the money now bypasses the banking system and goes straight into the pockets of the consumers. This would hopefully encourage consumers to spend money straight away instead of going through the process of borrowing money from the bank as is the case with QE.
Incomes Policy – wage-price spiral
The aim of an incomes policy in the 1960’s and 70’s was to link the growth of incomes to the productivity so as to prevent the excessive rises in factor incomes which raise costs and hence prices. However the idea here is to generate higher incomes at all levels by using tax incentives and to encourage a wage-price spiral. This seems bizarre in the context of the 1970’s as this is what governments were trying to solve.
Capital spending on infrastructure is seen as a much more effective tool to stimulate growth than tax cuts. Unlike tax cuts, capital spending goes directly into the circular flow and it attracts complementary spending elsewhere in the economy more than any other intervention. It is estimated that a third of roads in the USA are in a poor state and over 10% of its bridges are not structurally sound. However although it might sound a good idea, infrastructure spending can be wasteful as even many years of capital spending in Japan hasn’t had the desired effect of boosting the economy.
Where to from here?
The problem, then, is not that the world has run out of policy options. Politicians have known all along that they can make a difference, but they are weak and too quarrelsome to act. America’s political establishment is riven; Japan’s politicians are too timid to confront lobbies; and the euro area seems institutionally incapable of uniting around new policies.
Source: The Economist – 20th February 2016