Ten years on from the financial crash, we need to get ready for another one

[turbinetree]

Robert Skidelsky

The lessons of 2008 have not been fully learned: stop risky lending by banks, address fiscal policy and reduce inequality

The collapse of Lehman Brothers on 15 September 2008 unleashed the worst global downturn since the Great Depression of 1929. And it was almost entirely unanticipated. Ten years on is a good time to ask what governments, policymakers, and economists might learn from this catastrophe – how to prevent future ones, and how to overcome them if they happen. Of these two, prevention is far better than cure. Once a downturn gathers momentum, the scale of intervention needed to reverse it becomes frighteningly large. Budget deficits balloon, public debts soar, governments take over banks – all conjuring up visions of looming state bankruptcy, or worse, state control over the economy. So the most important question is: how can these catastrophes be prevented?

By prevention, I do not chiefly mean trying to stop the semi-regular fluctuations of the business cycle. Capitalist market economies exhibit rhythms of economic activity. The political economist Joseph Schumpeter called them waves of creation and destruction, or perhaps they simply arise from temporary mistakes of optimism and pessimism. The authorities already possess the tools to dampen, if not altogether prevent, these fluctuations – if they want to. Central banks can use interest rates to restrict or expand credit; government budgets have built-in stabilisers, with revenues falling when the economy turns down, and rising when it expands.

Beyond this, central banks could vary the reserve requirements of member banks counter-cyclically; local authorities could keep a buffer stock of public works – local improvements – which could be quickly expanded and contracted as unemployment rises and falls. Finally, there is a question of the “norm” around which the fluctuations might be allowed to occur. Should policy aim to maintain “high” full employment or be satisfied with “low’” full employment – the difference being between (say) an unemployment rate of 2-3% and 4-5%?

But the job of preventing economic collapses (of the order of 5% to 10% of national income, with unemployment doubling from “normal” times) requires far more ambitious thinking. Such collapses can happen at any time because, as John Maynard Keynes taught, the future is uncertain. It was the rapid spread of contagion through the banking system that brought it low in 2008. This was because big global banks held each other’s heavily insured risky assets. When the value of these assets collapsed, the banks and their insurers went bust. They then had to be rescued because they were “too big to fail”.

https://www.theguardian.com/commentisfree/2018/sep/12/crash-2008-financial-crisis-austerity-inequality


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What is hardly realised, even today, is that the rhetoric supporting this policy of deficit-cutting in a slump gets almost no support from economic theory. The national debt is not a “burden on future generations”; it is a transfer between creditors and debtors. Such transfers may have undesirable distributional effects, but no net burden arises, either now or in the future.

Much more important was the false argument that cutting public spending promotes recovery by increasing the confidence of the business community. This doctrine of “expansionary fiscal consolidation” was much in vogue in 2010. It is false, because businesses invest when they see a market, and the market expands when consumers have more money to spend. If government, in an attempt to “balance the books”, reduces the community’s spending power, economic recovery stalls. And this is what happened. Osborne’s cuts chopped down the “green shoots of recovery” that had begun to appear at the end of 2009, and condemned Britain to at least two further years of stagnation. In fact, the effects of his “cure” linger still, in the form of lost output and earnings.


Even though this is written for the British Population, it can also be used here in the United States.....................