How Prepared Are We for the Next Economic Crisis?
WASHINGTON—Economists and policymakers differ widely on when the next recession will be upon us. Some don’t even acknowledge the necessity for a severe downturn in the United States, arguing that fiscal and monetary controls are available to adjust and stimulate the economy, as was done in the Great Recession of 2008. Many economists don’t believe another recession is on the horizon.
However, there is a consensus view that the recovery from the Great Recession has been weak, and many indicators are signaling that a recession is at our doorstep and inevitable. In January this year, we had an ominous sign. The market had its worse 10-day beginning since 1897. According to CNN Money, the Dow was down 5.5 percent and the NASDAQ was down 8 percent, putting a scare in investors.
Negative Interest Rates
What can be done to avert the next recession or minimize the damage? One idea that is being bandied about is negative interest rates. A commercial bank receives interest on reserves held with the central bank (that is, the Federal Reserve), but the latter could instead impose a fee on the reserves. Negative interest rates could provide some stimulus to the economy, which might be preferable to other alternatives.
The aim is to bring about “declines in a broad range of longer-term interest rates, such as mortgage rates and the yields on corporate bonds,” wrote Ben Bernanke, on his blog, March 18. He is former Fed chairman and now at the Brookings Institution.
So in order to have your bank hold your savings, instead of receiving interest, the bank would charge you interest. Lest you think this is an absurd idea and something U.S. banks would never impose, negative interest rates are already a fact of life in Sweden, Denmark, Switzerland, Japan, and the eurozone. The largest negative rate is Switzerland’s, which is about -0.75 percent (-0.0075). Hungary became the latest monetary authority to make deposit rates below zero. Norway could be next.
Bernanke thinks it unlikely to happen here. He writes that the potential benefits of negative rates could be counterproductive and “trigger hoarding of currency.”
On March 21 at Brookings Institution, a panel of eight experts discussed fiscal and monetary policy tools that could be instigated in the event of a recession, and how these could be fine-tuned based on the 2008–2009 Great Recession.
The panelists held fairly orthodox views regarding the state of the economy. Four had worked for the Federal Reserve (“Fed” for short), another had been a high official at the U.S. Treasury, and one panelist (Jared Bernstein) was well-connected with the current administration as Vice President Joe Biden’s economic adviser.
In many respects the economy does look vulnerable, or at a minimum, very concerning, particularly the humongous federal debt. David Wessel, director of the Hutchins Center on Fiscal and Monetary Policy at Brookings, cited data (Auerbach and Gale) on the ratio of public debt to the GDP (gross domestic product, a measure of the economy). The ratio is higher now at 76 percent than at any time since the end of World War II. The federal debt will exceed the size of the economy by 2028.
Wendy Edelberg, an economist at the Congressional Budget Office, said that the high and rising debt increases the likelihood of a fiscal crisis. “Lawmakers would have less flexibility to use tax and spending policies to respond to unexpected challenges,” she said at the Brookings discussion.
The federal government through the budget and tax policy has tools available—”stabilizers”—so that when a downturn or recession occurs, the impact on people can be quickly moderated. In many cases, stabilizers take effect automatically, pointed out Jared Bernstein and Ben Spielberg, in a paper on preparing for the next recession, which was summarized at the discussion.
“[Automatic stabilizers] are programs that expand when the economy is weak and contract when the economy is on its way to recovery,” said Ben Spielberg, who is from the Center on Budget and Policy Priorities.
An example of an automatic stabilizer is the increase of those “eligible for SNAP (formerly called food stamps) and unemployment insurance (UI), putting money in their hands to spend and, thus relieving their hardship while boosting the economy,” states their paper. Federal income tax is another example because as individuals fall in income, their tax bracket may fall and therefore, they retain more income.
The authors recommend that these automatic stabilizers be expanded and new ones enacted, such as higher federal payments to states to cover Medicaid costs.
Edelberg said that automatic stabilizers impact the federal budget, particularly the size of the annual deficit. When the economy weakens, the automatic stabilizers increase government expenditures and reduce revenues; the reverse happens when the economy strengthens.
That may sound good, but Edelberg notes a cost: “CBO estimates that sustained higher deficits lead to lower GDP, lower economic output in the longer term, by crowding out national saving and domestic investment, which is to say, CBO estimates that higher federal borrowing crowds out private investment.”
In the last recession—the Great Recession of 2008–2009—Congress stepped in and rescued the financial sector and boosted the economy. It led off with the TARP (The Troubled Assets Relief Program, 2008), followed by the Economic Stimulus Act of 2008, and the American Recovery and Reinvestment Act (ARRA) of 2009.
Phillip Swagel, who was at the Treasury from Dec. 2006 to Jan. 2009, where he advised Secretary Paulson, said he favors a fiscal policy with new stimulus spending if a recession comes, but he said the quality of the spending is key. First we need to agree, he said, “not to just burn taxpayer resources.” He used the examples of high-speed rail and “green-pork” as wasted money, whereas money for pre-school teachers is not.
The big question is, Wessel asked, “given that debt level that we have today and given the political environment … would Congress be willing to do [fiscal measures] again [and] could we do it again?”
Federal Reserve Intervention
Another possible intervention if we have a recession is what our nation’s central bank, the Federal Reserve, might do. Before the outset of the last recession in 2008, the Fed had $850 million debt. Today, that has grown to $4.5 trillion in assets. Known as quantitative easing (QE), the Fed introduced several rounds of securities purchases—mostly Treasury securities and mortgage-backed securities—to inject more money into the economy by adding reserves to the commercial banking system, hoping that the banks would lend more money.
Increased loan activity by the banks did not materialize as hoped. It’s hard to know why, but in any case, QE has had little impact on stimulating growth.
“One of the questions we will ask is so, what’s wrong with 5.5 or 6.5 or $7.5 trillion? Is there some limit to what the Fed could do with QE, and is there some reason to believe that additional quantitative easing wouldn’t have the same effect as this did before?” asked Wessel.
Reduce Interest Rates
The Fed has also cut interest rates to induce lending institutions to loan money. Interest rates have been at or near zero. Last December, the first rate increase of 0.0025 percent, was the first time in seven years. But the Fed backed away in March from its intention to raise it another quarter point.
But now with short-term rates hovering at zero, interest rate reduction today has limited use. In the past, the Fed had “cut the short-term interest rate by 6.8 percentage points in the 1990–91 recession and its aftermath, by 5.5 percentage points in the 2001 recession, and by 5.1 percentage points at the beginning of the Great Recession in 2007–2008,” Bernanke writes.
A ‘Big Drop’ Coming
The experts quoted so far in this article basically share the same view of the economy and the use of fiscal and monetary policy to keep it from imploding. They don’t view with alarm the Fed’s holdings increasing five-fold to $4.5 trillion and what’s in them. We saw Wessel casually entertaining the idea of adding more trillions.
James Rickards, editor of the monthly financial newsletter “Strategic Intelligence” and author of “Currency Wars” and “The Death of Money,” said these experts fail to grasp how close we are to a major crisis at least as great as the 2008 near-meltdown.
In the book “The Big Drop” (2015), Rickards writes about how the Federal Reserve, policymakers, finance ministers, and professors around the world use equilibrium models, which presume that when something is out of kilter, central planners and lawmakers can tweak the system and restore the equilibrium. However, year after year, the results their models produce are wrong. They’re smart people, Rickards said, but their economic models don’t describe the way the real world works.
In “The Big Drop” Rickards writes, “The United States is living through a depression that began in 2007.” He doesn’t mean a recession, which is defined officially as two consecutive quarters of decline. There can be growth in a depression, but the growth we’ve had is well below normal activity. From 1983 to 1985 during the Reagan years, growth averaged over 5.5 percent. “By contrast, growth in the U.S. from 2007 through 2013 averaged 1 percent per year,” he writes.
He recently told the business editor of the Epoch Times, Valentin Schmid, regarding the bailout of the Great Recession: “Clearly central banks have pulled out all the stops, they printed trillions of dollars, they’ve swapped trillions of dollars. They guaranteed the money market funds in 2008 and they guaranteed all the bank deposits. They did everything possible.
“We might have avoided something worse that might have happened, like the Great Depression, but none of that policy has been reversed. The Fed’s balance sheet is still bloated. … They haven’t been able to normalize policy since 2008.”
“These crises come every seven to eight years,” Rickard said. “We go back to [Oct.] 1987, the stock market fell 22 percent in one day. Not a year, not a month but one day, 22 percent. By today’s Dow Jones Index, that would be the equivalent of 4,000 Dow points. … It’s been seven years almost eight years since the last [crisis]. How long do you think before another one comes? And yet they haven’t normalized policy, so what’s the Fed going to do the next time?”