Some readers may remember the 2007 and 2008 reports from the Bank of International Settlements (the central bankers’ bank). In July 2007 the blog titled its summary ‘4 risks to the world economy’, and July 2008’s was titled ‘The difficult task of damage control’.
Not all of the BIS’s forecasts proved correct, but it was the only major financial institution that came remotely close to forecasting the current downturn. Thus the blog paid particular attention today to an article by the author of those reports, William White, who has now retired from the BIS, and is therefore free to speak his own mind. White’s key points are as follows:
• Trying to avoid recessions “at all costs” is a dangerous policy. White believes today’s problems could have been avoided if central banks had not cut interest rates in previous downturns eg the 1997 Asian crisis, 1998 Long Term Capital Management collapse, and the 2001 dot-com debacle.
• He says the result was equivalent to allowing “undergrowth to accumulate in a forest“. It made “subsequent downturns more dangerous“, and “available policy instruments less reliable in response“.
• White argues that efforts to stimulate demand ignore the fact that we “also have an undergrowth problem on the supply side“. He cites autos, banking, construction, transport and distribution as examples of industries which have been allowed to become “too big and must be wound down“.
The core of White’s argument is that “many countries that relied heavily on exports as a growth strategy are now geared up to provide goods and services to heavily indebted countries that no longer have the will or the means to buy them”. In this, White allies himself with those, like the blog, who believe we face a “new normal” now recession is ended, where demand will be much slower than in the 2003-7 boom period, as people choose to save more, and spend less.
White argues that his former central bank colleagues don’t seem to understand that “good crisis management also contributes to crisis prevention“. He believes that cash-for-clunkers and other demand stimulation “policies are equivalent to trying to resuscitate a patient long since dead“. And he worries that by encouraging the current boom in asset prices they risk creating “yet another boom-bust cycle“, far worse than anything we have yet experienced.