Could the Recovery After the Great Recession Have Been Quicker?

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The party of nearly uninterrupted growth since the Reagan economic recovery of 1983 with the exception of two small recessions in 1990-1991 and 2002-2003 in the United States ended with a thud, culminating in the financial crisis of 2007-2008 and the Great Recession of 2007-2009. Unemployment had risen to double digits and inflation fell raising fears of deflation as in Japan. Therefore, interest rates were cut deeply by the Federal Reserve to the zero bound and money supply was further expanded through bond purchases and purchases of mortage-backed securities (MBSs) in three episodes of quantitative easing. Yet the economic recovery since 2009 has been sluggish. All that money supply perhaps achieved was to put a floor under inflation but not accelerate real investment through the credit channel of monetary policy transmission.

It has taken 7 years to nearly halve the unemployment rate with little to say about the quality of employment created. Rise in wages has been slow and people have not been able to find employment and incomes comparable to what they have been before the Great recession. Economists have cited technology and trade as two reasons for the plight of the average American as gains from both technical change and international trade have gone disproportionately to the top 10%, and more so to the top 1%. Innovation in all sectors, including in finance, was encouraged with little regulation. Technical change and trade have become dogmas whose critique was forbidden. As a result, populism and protectionism are now on the rise around the world as can be seen from Brexit in the United Kingdom and the election of Donald Trump for president in the United States.

The blame for the rising populism and protectionism must squarely be laid on the lack of substantive discussion among policymakers about how to safeguard jobs amidst technical change in manufacturing – a key employment sector of the economy – and how global trade must be structured for its benefits to be equitably distributed among the population. More importantly, under the grave threat of deflation after the onset of the Great Recession, monetary and fiscal policies have not been commensurately radical in a timely manner.

There was much deliberation whether to cut interest rates to zero during the initial period of the financial crisis, then it was followed by further deliberation whether quantitative easing should be adopted. Monetary easing occurred in an environment of fiscal tightening or austerity, a contradictory approach to macroeconomic policy making. While fiscal policy was constrained from acting through austerity measures, there has been no discussion on how monetary expansion can be conditioned on real investment rising to direct money to those sectors of the economy where it is most needed.

The extremely radical approach of the central banks in developed countries directly funding government budgets with the central banks forgiving all new government debt so that fiscal space can be increased to raise real investment to create jobs (“helicopter money”) has largely been left to opinion articles by former central bank policymakers and academics when the required global infrastructure spending alone is estimated to be USD 57 trillion by 2030. All of this has needlessly prolonged the economic recovery: money is being hoarded at central banks in the form of excess reserves and in cash by corporations instead of being invested in the real sector.

Predicating economic recovery on money from central banks trickling down into the economy and into sectors decided solely by market forces has made monetary policy less activist than it should have been for the recovery to be quicker. It is still not too late.

Demonetization, Jan-Dhan Yojana, and Digital India

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The surprise demonetization of large (INR 500 and 1000) denomination currency notes (to be replaced by newly designed notes later) and restrictions on automated teller machine (ATM) and bank withdrawals of cash have indeed affected day-to-day commerce in India that depends mostly on paper money and coin. This will, therefore, prove to be an inconvenience to a large part of India’s population and, according to the government, may continue to do so for about 60 days from the date of demonetization but has major implications for the future of base money in India.

The primary motive for India’s demonetization of currency notes of large denominations has been to ferret out the money that has not been accounted for as income for the purposes of taxation. This money, also known as “black money” that runs a shadow economy, is estimated to be as high as about one-fifth or 20% of India’s gross domestic product (GDP) or about USD 500 billion, larger than the economies of some countries.

Typically, hoarders of unaccounted for cash in India use that money to engage in all-cash transactions to buy – unknown to the tax collectors – real estate, stocks and other financial assets, foreign currencies, and gold. India also has a long list of people who have intentionally defrauded the banks by not paying back large sums of loans and also those who have stashed away gold and cash in secretive Swiss bank accounts. Forcing black money into light through demonetization and future digitization of financial transactions ends the underground economy.

Sweden, the first country to introduce paper money in the 17th century, is already contemplating becoming the first country to issue digital money because in Sweden, and in the Nordic countries in general, using paper money is fast going out of fashion, with people shifting mostly to all electronic transactions, both large and small, which can be traced and tracked and fully accounted for. This could be a trendsetter for the rest of the world for both convenience and to severely limit criminal activity such as money laundering and money unaccounted for by the tax authorities of governments.

India is a dreamscape for financial technologies (fintech) given the sheer volume of monetary transactions especially as the economy grows in size in the future. Paytm (short for “Pay through mobile”), a fintech e-commerce company, took out a full page advertisement in India’s major newspapers the day after India’s prime minister Narendra Modi announced the demonetization. The advertisement thanked the prime minister for pushing the country more towards the use of electronic monetary transactions and moving the country away from the paper currency-based economy.

The penetration of mobile phones in India has reached an astounding 1 billion mobile subscribers in a country with a population of about 1.3 billion. When so many people can use mobile phones with ease, it is only a matter of time before they also learn to transact using mobile technologies such as the Unified Payments Interface (UPI) which can transfer money between bank accounts using a text (Short Message Service, SMS) message between mobile phones. SMS simply uses the wireless phone signal and does not require internet access.

Even if some mobile applications (also known as “apps”) require internet access and smart phone use, the smart phone market is a rapidly growing market in India and telecommunications companies such as Reliance Industries with initiatives such as Jio are pricing telephone and data wireless internet services at a rate that can be afforded by the common man. Soon Reliance’s competitors will catch on and catch up in the market place.

Another initiative of the government, Jan-Dhan Yojana, which literally means People’s Money Scheme, aims at massive financial inclusion of the many unbanked poor and rural population of India. As many of them have access to mobile phones, with technologies such as UPI it is only a small next step to avail electronic banking and other financial services for amounts small and large.

Demonetization, Jan-Dhan Yojana and Digital India are mutually consistent government initiatives which are moving India in the right direction.

The End of Globalization As We Know It or New Globalization?

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Brexit in the United Kingdom and the election in the United States of Donald Trump for president have shocked observers out of their complacency that all is well despite the loud murmurs to the contrary from the people of developed countries for sometime since the Great Recession of 2007-2009. The social and political backlash and anger against the rise of income disparity and the uncertainty of livelihoods and income particularly since the prolonged slow economic recovery beginning in 2009 was widely underestimated by the political and economic elites. Both Brexit and the election of Donald Trump have been a loud call for change in the economic status quo on both sides of the Atlantic asking for the benefits of globalization to be equitably distributed across the income ladder.

The capacity of open developed economies to absorb the imports from developing into developed countries at the expense of domestic investment and employment in developed countries has become strained since the fall of the Berlin Wall in 1989 after which the current episode of globalization began. At the same time the investment needs to renew infrastructure and energy in advanced open economies are not being met because of the built-in inability of monetary policy to direct private investment where it is needed most and rising fiscal deficits due to the aging of the populations and slowing growth, particularly after the 2007-2008 financial crisis. Therefore, despite extraordinary monetary easing and the concern about budgets, fiscal expansion in the form of higher government spending appears to be the last resort to trigger private investment, complement the current monetary stance, and to facilitate gradual monetary tightening. As a result of Trump’s fiscal expansion and any attendant rise in real investment due to the still easy monetary policy despite the Fed’s rate increases, if US potential growth rises there will not be a significant rise in inflation.

Trump has promised to address all of the above issues in trade policy (which will particularly affect American economic relations with Latin America, Asia and Europe) and fiscal policy. The economic program of his presidency is premised on three things: (1) renegotiating trade deals including the North American Free Trade Agreement (NAFTA); (2) fiscal expansion (a) to renew infrastructure which will create jobs; (b) by reducing both personal and corporate taxes which could in the short run reduce tax revenue and increase the budget deficit but, according to supply-siders, in the long run increase revenue because of increase in growth; and (c) by giving a one-time tax break for repatriation of foreign profits of American multinational corporations (MNCs) which could give an immediate one-time boost to tax revenue; and (3) higher interest rates.

America renegotiating trade agreements impacts economic globalization the most. Trump, just as with asking the allies of the United States in Europe and Asia to shoulder the financial burden of their security more, also wants countries to be economically as open to the United States as the United States is open to them – either there will be reciprocity of other countries in trade with America or there will be mutual trade barriers, which is not good economic policy. Further, he wants to disincentivize American firms from moving jobs abroad.

Sentiments such as these when translated into policy will lead to a new kind of global environment for the multinational corporation: the MNCs have to learn to invest and produce in the various countries they operate for the local consumers rather than creating complex global supply and production chains to produce at low production, legal and environmental costs for consumers who buy their goods and services in wealthy countries. More importantly, an unintended positive consequence of hard-nosed negotiations by America under Trump is that the environment and human rights, which were overlooked in agreements such as NAFTA before, will now be factored into trade agreements and globalization because countries which allow American firms to produce within their borders in exchange for their firms being allowed access to the American market will also seek reciprocity on the environment and human rights.

We must all hope that, rather than throwing up protective barriers around the world and raising geopolitical tensions, the new globalization, evolving out of the consequences of the radical global economic liberalization since the 1990s, will be a sustainable one enabling the realization of the sustainable development goals (SDGs) – the 2030 Agenda for sustainable development which is a set of seventeen aspirational “Global Goals” with 169 targets between them – for the most important purpose of equitably distributing the gains of globalization among the peoples of the world.

Why is the Large Increase in Worldwide Monetary Base Not Causing Inflation As Expected?

Ever since the beginning of the Great Recession in the United States in 2007, monetary base has been increased sharply by central banks worldwide to prevent what could have, as some argued, turned into a depression. Monetary base (or MB) is the sum of the notes and coins in circulation (currency), required reserves and excess reserves of commercial banks held at their central bank, and notes and coins in bank vaults (vault cash).

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The purpose of the increase in monetary base has been fourfold: (1) to provide liquidity during the financial crisis; (2) to support economic growth; (3) to prevent deflation from taking hold; and (4) to cause inflation to meet central bank targets. Japan’s monetary base has also increased substantially after the commitment from Bank of Japan to significantly increase money supply to combat chronic deflation and to return inflation to its 2% target. So, why is not all of this increase in high-powered money causing inflation as expected by the central banks? After all, though many disagree on the merits of the theory, the quantity theory of money (QTM) which underpins monetarism in monetary economics postulates that the price level must rise when there is an increase in base money supply.

It can be argued that the severity of the Great Recession worldwide has been such that, had it not been for the sharp increase in global monetary base, a deflationary mindset as in Japan would have taken hold with prices falling further and further with the hope of triggering a rise in aggregate demand and consumers taking longer to spend waiting for the prices to fall some more. A depression was perhaps indeed avoided by providing the much needed liquidity to the financial markets during the cash crunch of the housing crisis.

The sharp increase in the base money had indeed met three of its four objectives in a particularly severe crisis. The recession ended in the United States in 2009 with demand, economic output and prices rising, only that the rise in prices has not been to the satisfaction of the Federal Reserve given its inflation target of a rise in core personal consumption expenditures (PCE) of 2% year-on-year (y-o-y).

Four factors are holding back a further rise in inflation: (1) the global slowdown in the rise of economic output (with the exception of India) has reduced the demand for fuel and food making them cheaper in sharp contrast to the prices of fuel and food in the run up to the Great Recession. The excess supply of fuel has the effect of a positive supply shock and this coupled with the negative demand shock of moderate to low demand for fuel due to a slow economic recovery has a further depressing effect on the over all price level; (2) excess reserves of commercial banks held at their central banks have balooned to very high levels, in the order of trillions of dollars, euros and yen, taking that money out of circulation; (3) the reluctance of corporations to make capital investments given their low to moderate outlook for demand growth for their products and services but instead to raise their stock prices by buying back stock with borrowed money at very low yields on their corporate bonds has limited economic growth, reduced risk premiums on financial assets and artificially elevated the values of financial assets; and (4) corporations are hoarding cash rather than choosing to raise real investment.

The sharp rise in monetary base in the aftermath of the Great Recession has prevented a deflationary psychology from taking hold and has supported economic growth. To return to healthy inflation at central bank targets, the factors that are mitigating the rise of the price level must ease but do so gradually over time so that runaway inflation does not occur.