They were all there. Mario Draghi, in his last few weeks as president of the European Central Bank before handing over to Christine Lagarde; Mark Carney, who will be leaving the Bank of England in January provided the UK government ever finds the time to appoint a new governor; and Jay Powell, the man Donald Trump now deeply regrets ever choosing to run the Federal Reserve.
Yet all these members of the financial elite were upstaged by someone who retired from the central banking fraternity six years ago. Lord Mervyn King showed up in Washington to give the Per Jacobsson lecture, a showcase occasion at the annual meeting of the International Monetary Fund, and proceeded to make by some distance the most arresting intervention of the week.
King’s argument was simple. The synchronised slowdown in the global economy identified by the IMF’s new managing director – Kristalina Georgieva – is more than a temporary phenomenon. Instead, it is a reflection of how the failure to address the reasons for the financial crisis of 2008-09 has left the world economy stuck in a permanent low-growth trap.
Policymakers have patted themselves on the back for the way in which their emergency action at the height of the banking meltdown in 2008 prevented a repeat of the 1930s. By cutting interest rates, creating new electronic money and bailing out the banks, governments ensured there was nothing like the loss of output or the increase in unemployment seen during the Great Depression.
But look at it another way, King said, and the comparison is not quite so flattering. In the US, the economic horrors of the 1930s were followed by stupendously rapid growth in the 1940s. There was a big drop in activity in the years after the Wall Street Crash but by 1950 the US economy was back to where it would have been had the economy continued on its pre-Great Depression growth trend of 2% a year.
Now take the 20-year period between 2008 and 2028. Assuming the US economy grows in line with the IMF’s forecasts of just below 2% a year on average between now and 2024 the world’s biggest economy would need to grow by 5.5% a year between 2025 and 2028 to regain its pre-2008 growth path. That looks like a tall order given the US has not even approached those rates of expansion on a sustained basis for half a century. What’s more, the US has performed a lot more strongly than other developed countries: recovering more quickly and growing more strongly than the eurozone, for example.
But the Great Depression led to big changes in economics – the Keynesian revolution – and this paved the way for a political rethink. The same applied to the mid-1970s, when the shift to the political right was made possible by a group of economists who challenged the Keynesian orthodoxy.
King’s view – and he is right – is that there has been nothing remotely comparable since the financial crisis of 2008. Economies have been kept ticking over by monetary easing – low interest rates and quantitative easing – but none of the fundamental issues have been tackled.
This is not just a question of the law of diminishing returns, with each dollop of stimulus proving less effective at boosting activity than the last. It is also, as the IMF noted last week, creating the conditions for the next financial crash. Why? Because when central banks send out the message that interest rates are going to stay low for ever it encourages individuals and companies to load up on debt. This is fine until a recession arrives causing individuals to lose their jobs and companies to see product demand collapse. In those circumstances, the debt becomes unpayable, and a wave of bankruptcies amplifies the initial economic shock.
Most central bankers are aware of the limitations of monetary policy. Carney said in Washington that there was the risk of a global liquidity trap – where people hoard cash and even rock-bottom interest rates are ineffective. Draghi would agree with the IMF that countries such as Germany and the Netherlands should run down their budget surpluses to take some of the pressure off the ECB.
In the short term, policymakers are going to shift towards a more active use of fiscal policy, cutting taxes and increasing public spending. The UK chancellor, Sajid Javid, said in his flying visit to Washington last week that it made sense to borrow money for infrastructure projects when the government could borrow money at such cheap rates, and he is absolutely right about that.
But with debt levels high, governments are going to be quite cautious about deploying the sort of fiscal stimulus that would really make a difference. In any event, the global deficiency of demand is a structural problem that requires a structural response.
Both King and his successor have their solutions. Carney says one big problem is that the dollar is too powerful a reserve currency given that the US share of global GDP is shrinking. He says changes in technology make it possible to envisage a new digital currency that could be provided through a network of central banks and would eventually rival the dollar.
King says there need to be country-specific changes so that, for example, China and Germany become less export dependent while other countries become less reliant on commercial property.
Resolving the global imbalances between countries that save too much and those that save too little was a familiar refrain of King when he was the Bank’s governor. The fact that he is still singing the same song shows how little has changed. And that is deeply concerning.