Yet this is where the bad news comes in. As our special report this week sets out, the rich world in particular is ill-prepared to deal with even a mild recession. That is partly because the policy arsenal is still depleted from fighting the last downturn. In the past half-century, the Fed has typically cut interest rates by five or so percentage points in a downturn. Today it has less than half that room before it reaches zero; the euro zone and Japan have no room at all.
Policymakers have other options, of course. Central banks could use the now-familiar policy of quantitative easing (QE), the purchase of securities with newly created central-bank reserves. The efficacy of QE is debated, but if that does not work, they could try more radical, untested approaches, such as giving money directly to individuals. Governments can boost spending, too. Even countries with large debt burdens can benefit from fiscal stimulus during recessions.
The question is whether using these weapons is politically acceptable. Central banks will enter the next recession with balance-sheets that are already swollen by historical standards—the Fed’s is worth 20% of GDP. Opponents of QE say that it distorts markets and inflates asset bubbles, among other things. No matter that these views are largely misguided; fresh bouts of QE would attract even closer scrutiny than last time. The constraints are particularly tight in the euro zone, where the ECB is limited to buying 33% of any country’s public debt.
We are living today in a world that was previously unimaginable. Negative interest rates have been with us for a decade and about $7 trillion has negative yields. Investors would literally rather pay to own bonds. Meanwhile some of the largest privately held companies continue to attract tens of billions in capital with little prospect of near-term or even medium-term profits. Therefore, I find it had to fathom why people are so reticent about embracing the possibility that even more drastic action will not be embraced if the current suite of policy tools is exhausted.
For example, the ECB’s limitation on how much debt it can buy is completely arbitrary. It could be amended with the keystroke. When the ECB took €1 trillion off its balance sheet I’m sure they never envisaged having to add more than double that figure back on just to get back to where they started. The Federal Reserve is trying hard to reload its policy arsenal by raising interest rates and reducing the size of its balance sheet with the full expectation that it will all of those tools during the next recession.
It is anathema to the markets today, but debt forgiveness was pursed during the Great Depression. It was not even considered in the Great Recession and the alternative of quantitative easing and foreclosure, which impoverished millions but enriched the asset wealthy, is one of the primary causal factors behind the rise of populism. It would therefore not be so surprising to hear calls for debt forgiveness become more vocal in a future recession.
The actions of the Swiss and Japanese central banks in buying the shares of companies with real world businesses are probably some of the most prescient actions of any country. There is a clear logic to owning hard assets with cashflow potential rather than paper commitments as a backstop to a nation’s currency in a time of crisis. The clear conclusion they have made is that they see greater security in company cashflows than in gold or bonds.Back to top