Debt isn’t always bad, fearing inflation is stupid and governments should spend far more, suggest top economists.
Any gathering of economists since the financial crash has usually been an occasion for blinkered self-justification. In most cases these self-styled scientists cannot bring themselves to admit they missed even the most basic signals that flashed red as we headed ever faster towards the abyss. It must be said some have looked at their models and concluded they were flawed, either because they excluded the potential for wild excesses in the banking system or because they assumed people behave rationally when confronted with economic choices. Most have not.
In the Bavarian town of Lindau, where 18 Nobel-winning economists gathered last week along with 450 graduate economics students from around the world, the atmosphere was a little more challenging and the previously meek response of those who criticise conventional thinking had grown louder and more coherent.
Princeton university professor Christopher Sims threw the first punch. Monetarists, he said, believe that an expansion of debt is like an expansion of money and can cause inflation. There are two reasons why this view is wrong. The first is that interest is paid on this debt, so it is not free money. More importantly, the newly minted central bank debt, which amounts to more than $5tn (£3tn), is a weak policy that has failed to increase consumer demand and therefore has little effect on inflation.
To go back a step, the expansion of money by central banks, familiar to us as quantitative easing (QE), was sold to politicians as a way to encourage bank lending, increase consumer spending and generate moderate inflation. Sims said QE is weak when governments accompany the bond buying with dire warnings of the need to tackle these debts at a later date – either through cuts in expenditure or higher taxes.
Even without this threat, consumers had come to understand that ageing economies would need extra resources to cope with ballooning retirement and health costs. Under this dark cloud, today’s young people, unsure if they will shoulder all the burden, refuse to spend the money central banks generate.
Sims argued that households in the US, Europe and Japan are so pessimistic about the need for spending cuts that deflation, despite QE, is already with us and will continue to be for some time. Polling in the US shows that more than half of Americans believe social security will not support them in retirement and almost half of current retirees believe that at some point their benefits will be cut. No wonder those pensioners with money continue to save or help their children save. The future is uncertain and a little scary.
Sims was well aware he was speaking in a Germany that fears inflation much as the villagers in the Asterix comic books fear the sky falling on their heads. Without naming Angela Merkel, he said anyone who feels threatened by inflation is stupid.
His argument was neatly complemented by Vernon Smith, the 2002 Nobel prize winner who made his name analysing the internal workings of markets. He is no Keynesian. In fact he is a subscriber to the Austrian world view and would have allowed many more banks and businesses to go bankrupt than governments dared in 2008 and 2009. He likened the bailouts of pre-crash business owners to giving the carriage makers and horse owners of the 19th century a claim on the profits from Ford’s sales of Model Ts.
If we set aside his believe in the cleansing process of bankruptcy and rebirth in modern capitalism, what he had to say about the housing market took Sims’s analysis on a stage. He produced charts showing how the US housing market was already above its long-run average relative to median incomes by 2001, well before bankers starting selling sub-prime mortgages, mortgage-backed securities and other exotic derivatives of property values.
Worryingly, the US housing market has regained much of the value lost in the crash relative to average incomes. It is already halfway back to the peak. “I leave you to draw your own conclusion,” Smith said, knowing he had shown us another property crash was already in the making.
His analysis illustrates how consumers, too scared to spend central bank-created money for fear of future tax rises, are purchasing property instead. It is the same in the UK where it is considered a way of saving in a safe haven asset, not investing in something risky.
As Smith points out, its attraction over other more productive avenues for investment can be found in the tax regime, which allows property investors an almost free ride. So QE is not fuelling inflation, as the monetarists fear, nor is it creating bubbles in exotic assets around the world, at least not very big bubbles. It is all going into property assets and pushing us back to where we were around 2003-04.
Peter Diamond, an MIT economist and Nobel winner in 2010, said governments should shoulder the burden of sparking economies back to life with extensive infrastructure spending. While it might be four years after he first recommended it, the positive effects on unemployment and reductions in social security spending would outweigh the costs of new railways, universities and bridges many times – let alone adding in the benefits of an increased capacity to produce higher-grade goods with better qualified workers.
A keen analyst of unemployment trends, Diamond said it was criminal that governments rejected state-sponsored investment, especially when they can borrow money almost for free.