Today, we are at the beginning of just such a process. It took a decade and a Second World War to understand what had really caused the Great Depression in the 1930s. Now we can take a longer view of the Global Financial Crisis, and the recession that followed, and assess how effective the responses to them have been.
The remedies to recession proposed by orthodox policy have failed. The German insistence on austerity, smaller government and eliminating deficits has led directly to the travails of the euro zone and the real threat of renewed recession, with the result that countries like Greece and Spain are in desperate straits. The continued viability of the euro itself is at risk.
The British, despite all George Osborne’s chest-beating, have endured five years of austerity and the longest and deepest recession in modern times. Living standards have still not returned to pre-2008 levels. Such prospects as there are for the future rest on an unsustainable consumer boom and asset inflation in the housing market.
The more moderate approach, the relaxed monetary policy and greater government involvement put in place by President Obama have produced, by contrast, a partial recovery in the American economy.
Neo-classical economics have failed to produce a solution to the problems created by the Global Financial Crisis and the policies that were put in place before the GFC – and were responsible for bringing it about in the first place – are now being pursued all over again, with every likelihood that they will produce the same outcomes.
The simple certainties that were the basis of the monetarist revolution that began in the 1980s – that national economies were just like private businesses, that there was little role for government, that the market could safely be left to produce optimal outcomes, that restraining inflation through controlling the money supply should be the only goal of macro-economic policy – are wrong.
Future historians will mark this decade as the point when the counter-revolution began. At the heart of that new thinking will be a re-assessment of what monetary policy is and should be about.
Shinzo Abe’s government in Japan, and even more dramatically the newly elected government in Greece, renouncing austerity. Central banks - the Federal Reserve, the Bank of England, the Bank of Canada, the Bank of Japan and now even the European Central Bank – have dramatically relaxed monetary policy and printed large quantities of money.
A school of thought calling itself Modern Monetary Theory argue that monetary policy is the key to economic growth. Monetary economists like Adair Turner are prepared to contemplate what is usually (and pejoratively) called “helicopter money” to raise the level of demand, and for the first time there is interest in the West in the work of Osamu Shimomura, widely recognised as the father of the Japanese miracle of the 1960s and 1970s.
Look at the seminal paper published in the Bank of England Quarterly Review in March last year. That paper conceded (the first such concession made by any major central bank) that 97% of the money in the UK economy was created out of nothing by the banks.
The whole basis of monetarist policy was thereby revealed to be a charade. Governments may cut spending and impose austerity, and may raise interest rates in a vain attempt to control the money supply (while doing unnecessary damage in passing to investment in the real economy), but the banks go on printing money as though there is no tomorrow. The greater part of that new money is created – not for productive investment – but for house purchase, and all of it for private profit rather than the public good.
This huge increase in the volume of money, most of it directed into the housing market and unbacked by any corresponding increase in real production, has inevitably created a huge asset inflation, a dangerous bias in the economy in favour of speculation and against productive investment, a major driver of inequality between those who own property and those who do not.
Banks profits soar, the bonuses they pay themselves multiply in size, and their ability to create wealth out of nothing means that the asset bubbles that eventually burst to bring about the Global Financial Crisis are again being inflated as we watch.
In the 1980s, financial services were deregulated, governments withdrew from macro-economic policy, banks moved in to displace building societies as the main suppliers of mortgage finance, restrictions on capital movements were removed. The result? The banks discovered that lending on house purchase was hugely profitable and almost risk-free, and that there was in practice no limit to how much money they could create; the only constraint was the presence or otherwise of willing borrowers. While governments strained every sinew to “control the money supply” and their own spending, the banks’ ability to create new money through the stroke of a book entry continued unabated.
A recent study by the National Bureau of Economic Research in the US of bank lending in twenty countries and over long periods shows an undeniable link between the increase in the money supply (though even these expert authors seem not to quite understand how that increase happens) on the one hand and asset inflation in the housing market and an increased risk of financial crises on the other.
The outcomes of this huge shift in economic power, away from governments and in favour of banks, are felt everywhere in our daily lives – in housing costs, in jobs, inflation, government spending, growth rates, balance of payments. Yet the change is hardly remarked, let alone understood. That is about to change – and not before time.
10 February 2015