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The author is a professor of economics and public policy at Harvard University and former chief economist of the International Monetary Fund (IMF).
Suisse National Bank threw a huge lifeline to struggling Credit Suisse on the heels of the Federal Reserve’s broad action to prevent systemic fallout from the Silicon Valley Bank collapse. It shows that leaders in the financial world are determined to take decisive action when fear begins to breed. Let’s talk about moral hazard another day.
But even if the risk of financial doomsday in 2023 is contained, not all differences between today and 2008 are reassuring. At that time, there was no inflation problem, but deflation soon appeared, that is, the price continued to fall. With core inflation still high in the US and Europe today, it’s impossible to claim that current inflation isn’t a problem except with extreme exaggeration in explaining what “temporary” means. In addition, both public and private debt have increased substantially globally. If, looking ahead, long-term real interest rates are set to fall sharply, as they did during the secular stagnation period in the years leading up to 2022, this will not be much of a problem.
Unfortunately, however, ultra-low borrowing rates are not expected this time. First, I think that if one looks at the long-term historical pattern of real interest rates (I did this analysis with Paul Schmelzing and Barbara Rossi), there are significant Shocks — such as the sharp downturn after the 2008 financial crisis — tend to wane over time. There are also structural reasons: at one point, the surge in global debt (both public and private) after 2008 was partly a natural response to low interest rates and partly a necessary response to COVID-19. Other factors that are pushing up long-term real interest rates include the massive costs of the green transition and imminent increases in defense spending around the world. Rising populism will presumably help reduce social inequality, but higher taxes will reduce trend growth, even if greater spending will add upward pressure on interest rates.
This means that, even after inflation subsides, central banks may need to keep interest rates generally higher over the next decade than in the previous decade just to keep inflation stable.
Another big difference between the current period and the post-2008 period is that China is much weaker now than it was then. Beijing’s fiscal stimulus after the 2008 financial crisis has played a key role in sustaining global demand, notably for commodities but also for German manufacturing and European luxury goods. Much of that stimulus money has flowed into real estate and infrastructure, the massive sectors on which China’s economic growth rests.
However, after many years of heavy construction, China has encountered the same problem of declining investment return, which is the same problem that Japan encountered in the late 1980s (think of the famous “Bridge to Nowhere”) and the Soviet Union in the late 1960s. . This, combined with the over-centralization of decision-making, very unfavorable demographic changes, and quietly deglobalization, it is clear that when the next global recession hits, China will not be able to play the extra role in supporting global economic growth as it did last time. significant effect.
Last but not least, the 2008 crisis occurred during a time of relative global peace, which is not the case now. Russia’s war in Ukraine has unleashed a persistent supply shock that is responsible for a large part of the inflation problems central banks are now grappling with.
Looking back at the stress the banking sector has endured over the past fortnight, we should be thankful it didn’t happen sooner. With the central bank raising interest rates sharply, in a difficult economic environment, it is inevitable that many companies will fail, and normally some emerging market debtors will not be able to survive. So far, several low- and middle-income countries have defaulted, but more are likely to default. In addition to the technology industry, there will certainly be other industries experiencing problems, such as the commercial real estate industry in the United States, which has been hit by the continuous rise of interest rates, even though the occupancy rate of office buildings in major cities is still only about 50%. Of course, the financial system will inevitably bear some losses, including the less regulated “shadow banking”.
Governments in advanced economies are not necessarily safe. They may have “graduated” from the sovereign debt crisis long ago, but not yet from partial defaults caused by sudden high inflation.
How should the Fed weigh all these issues in its decision on interest rate policy this week? After the turmoil in the banking sector, it is clear that it will not raise interest rates by as much as 50 basis points (0.5%) like the European Central Bank, which surprised the market on Thursday by raising interest rates. But then again, the ECB is following in the Fed’s footsteps.
Among other things, it is unreasonable to bail out the financial industry again while increasing the pressure on the common people. However, like the ECB, the Fed cannot comfortably ignore stubborn core inflation still above 5%. Maybe, if the banking sector looks calmer, the Fed will opt for a 25 basis point rate hike, but if there is still some unease in the air, the Fed will likely say that the direction of the rate path is still up, but a pause is needed one time.
Resisting political pressure is much easier at a time of downward interest rate and price pressures globally. Not anymore. Those days are over, and things are going to get increasingly difficult for the Fed. The trade-offs it faces this week may be just the beginning.
Translator/He Li