Seven Crashes, page 29
In November 2010, the Fed announced additional measures (QE2) that involved purchases of $600 billion of long-term Treasury securities, amounting to 4 percent of GDP, to be completed by June 2011. In September 2011 it moved into new territory with what it dubbed “Operation Twist,” or the Maturity Extension Program (MEP), selling short-term paper and buying longer dated securities, with the aim of increasing the appetite for risk and reducing long-term borrowing costs. Specifically, the Fed initially proposed to purchase $400 billion in Treasury securities with maturities greater than six years and to sell an equal amount of securities with maturities of less than three years, with implementation taking place over a period of nine months. In June 2012, the Fed extended the program through the end of 2012, so that it ultimately took $667 billion (or 4 percent of GDP) of long-term securities from the market. By that time, the yield on the ten-year Treasury bond had fallen to 200-year lows, and there was a considerable stimulus to the housing market. The Fed also announced that it would keep the federal funds rate at current low levels through 2014.
QE3 began even before Operation Twist was over. In September 2012, the Fed decided to start purchases of MBS of $40 billion per month, with no set end date. In December 2012, the Fed decided to continue Treasury purchases at the MEP rate of $45 billion per month indefinitely and to stop selling off shorter-term Treasury securities. Only in December 2013 did the Fed slow the pace of purchases to $35 billion in MBS and $40 billion in longer-term Treasuries per month, with further reductions until the program ended in October 2014. In all, the Fed’s purchases amounted to $1.5 trillion of Treasury debt and MBS under QE3, or 9 percent of GDP.
The most plausible empirical estimates suggest that around $300 billion of purchases (1.5 percent of GDP) should have an effect roughly equivalent to a 0.25-percentage-point cut in the policy rate.81 The purchases were designed to spur economic growth, but the recovery remained frustratingly sluggish, slower than previous recoveries from recession. A major effect, inevitable since monetary policy was working through asset purchases, was to push up asset prices generally. In consequence, the asset price boom of the so-called Great Moderation of 2001–2007 continued, with substantial rises in the value of stocks and real estate, especially in major global hubs. There was a politically dangerous side effect, then, that appeared to be pushing up wealth inequality in many countries.
The amount of central bank activity was staggering. The Bank of England from 2009 bought mostly government securities, but also increasingly private-sector securities. From 2011, it imposed a limit, so that no more than 70 percent of any issue of government stock would be bought up. Economic uncertainty produced by the outcome of the 2016 Brexit referendum required another large round of QE to support the economy. Japan, the original pioneer of QE, from October 2010, when it announced a ¥5 trillion asset purchase program, explicitly aimed at lowering the exchange rate of the yen.
The European dynamic followed the Fed example with a lag. In July 2009, the European Central Bank (ECB) introduced a nonstandard measure to revitalize the European covered bond market, which at the time financed about one-fifth of mortgages in Europe. Direct purchases in both primary and secondary markets amounted to a total of €60 billion of covered bonds for a year. A second program began in November 2011, but over the course of a year the ECB bought only €16.4 billion, well short of the targeted €40 billion. From October 2014 net purchases of covered bonds under a third covered bond purchase program (CBPP3) amounted to €290 billion.
The main attention of the ECB in the early stages of the European debt crisis, however, was more specifically focused on purchasing debt issued by the crisis countries, Greece, Ireland, and Portugal, and later as well Italian and Spanish debt under the Securities Markets Program (SMP). The purchases occurred in the secondary market to avoid contravening the rule against monetary financing of governments by the ECB (Article 123 of the Treaty on the Functioning of the European Union). In September 2012, the ECB also announced a conditional Outright Monetary Transactions (OMT) program, though in fact no purchases were ever made under that program. Europeans, in part because of the contentious character of a regional debt crisis, were in a greater hurry to exit the program than the Fed. In 2011, the IMF and ECB were broadly in agreement on the need for “gradual withdrawal of monetary stimulus” while continuing unconventional liquidity policies for some time. The IMF at this point put considerable emphasis on concerns about rising inflation.82
In July 2013, the ECB started to use forward guidance, stating that it expected policy interest rates “to remain at present or lower levels for an extended period of time.” It introduced negative interest rates on its deposit facility in June 2014, as well as targeted long-term refinancing operations, with the aim of easing private-sector credit conditions and stimulating bank lending to the real economy.83 For Europe, a substantial attraction of monetary action was that the distributional costs were not as evident or as clearly calculable as they were for the fiscal bailouts that had in 2010 been the initial official response to Europe’s debt crisis. The contingent character of the claims that built up made it impossible to really assess the costs to national taxpayers. In the creditor countries, the lack of transparency provoked the argument that the creditors were being lured into a trap that would necessarily, although unpredictably, involve large fiscal costs.84
There was a fundamental change in stance announced by ECB President Mario Draghi in a speech at the Fed’s annual monetary policy conference at Jackson Hole, Wyoming, in 2014. Draghi echoed the thinking that was widely imputed, especially by foreigners, to Fed policy—that one lever of the QE action was on the exchange rate: “We have already seen exchange rate movements that should support both aggregate demand and inflation.” But the major point was that monetary policy or central bank action alone was insufficient. There needed to be more coordinated fiscal action, which was becoming easier because of the reassuring effects of monetary policy on financial markets: “it would be helpful for the overall stance of policy if fiscal policy could play a greater role alongside monetary policy, and I believe there is scope for this, while taking into account our specific initial conditions and legal constraints.”85 The ECB started an equivalent program (Expanded Asset Purchase Programme) for buying €60 billion per month in March 2015, for eighteen months or “until a sustained adjustment in the path of inflation towards the ECB’s objective of lower but close to 2%” was attained. The purchases rose to €80 billion from April 2016 to March 2017, and were then reduced until the program ended in December 2018.
The central banks looked like rock stars, or the only grown-ups in the room—especially after the big political disputes about fiscal policy that marked the turning away from stimulus in 2010. But were their actions effective? On the whole the policy-makers were quite reserved. Bernanke engagingly explained: “the problem with QE is it works in practice, but it doesn’t work in theory.”86 His colleague Donald Kohn was more cautious: “I think it’s fair to say that, although these [steps] were effective to some extent, people—even the Fed—were somewhat disappointed. It’s been a slow recovery from a very deep recession.”87 The Fed governors noted in 2014, at the ending of the QE program, that “there has been a substantial improvement in the outlook for the labor market since the inception of the current asset purchase program.”88
The post hoc investigations confirmed this very muted optimism. In 2014, researchers from the Bank of England found that asset purchases have a statistically significant effect on real GDP, with purchases amounting to 1 percent of GDP leading to a rise of 0.36 percent in real GDP and of 0.38 percent in the consumer price index for the United States, and a rise of 0.18 percent in real GDP and of 0.3 percent in the consumer price index for the United Kingdom.89 Academic research was mostly skeptical about the magnitude of the impact of QE on U.S. long-term interest rates.90 Japan’s large-scale experiment stabilized the country but did not secure a return to higher growth, which remained at the lower end for the G7 countries, above only the dismal Italian performance.
Figure 6.3. Stock market indices, 2006 –2021 (2006 = 100) (Source: Global Financial Data)
The effect of central bank action on asset prices was much clearer, triggering renewed discussions of bubbles (see Figure 6.3). The November 2010 FOMC meeting started a long upward movement on U.S. stock markets. European stocks started to recover after 2015. The wildest rides occurred in large emerging markets, with speculative surges in 2014 in India, and most spectacularly in China. The latter collapsed in 2015 and then set off a blame game in which Chinese authorities blamed speculators and made some dramatic arrests. Xu Xiang (“Big Xu”) of Zexi Investment was seized after a car chase on the Hangzhou Bay Bridge. It was easier to scapegoat individuals than to reverse the monetary policy that had driven the market frenzy.
A New Economic Nationalism
Nationalism lay in the logic of stimulus packages funded out of tax money, which were intended to preserve national prosperity and national jobs. From this perspective, money spent would be less effective if it leaked out to other countries. Countries thus tried to ensure that increased purchasing power would be spent on local goods. France’s President Sarkozy urged the automobile producers Renault and Peugeot-Citroën to repatriate production from foreign suppliers and production sites. State-funded scrapping incentives encouraged drivers to trade in old cars in many countries, including Germany, France, Italy, the UK, and the United States (where they were celebrated as “cash for clunkers”). But the schemes often backfired. The German bonus, of €2,500 per car, launched in January 2009, seemed to benefit producers of cheaper cars in France, Spain, the Czech Republic, and Poland rather than Germany’s domestic and more luxury-oriented manufacturers. And the Central European producers fought back. Czech prime minister Mirek Topolanek, for instance, argued that “[a]ttempts to use the financial crisis to introduce forms of protectionism risk slowing and endangering the recovery of the European economy and the confidence of consumers and investors.”91
Governments also did not want to finance bailouts in other countries. This applied at first especially to banking rescues, where the most problematical cases were multinational enterprises, such as the Franco-Belgian Dexia or the Belgian-Dutch Fortis. Bailouts in these cases involved weighing up and then allocating the fiscal liabilities for two states. This consideration is what makes the European move to a banking union in the summer of 2012 so startling (it was the much-needed solution to the European sovereign debt crisis), but also explains why its implementation was so slow.92 The resistance to bailouts poisoned the whole discussion of European rescue mechanisms. Germany dragged its heels because of regional elections as well as court challenges; then small northern and eastern countries complained that money was being diverted to German or French banks, or to feckless Greek consumers and politicians, and that anyway the formerly communist economies were much poorer and should not be sending support to richer Greece.
Countries desperately needed new investment, but at the same time were allergic to selling enterprises to foreigners. Chinese investment in Greece, for instance in the port of Piraeus, was sometimes felt as an intrusion rather than a rescue. Germans were outraged by the sale of high-tech companies, such as the robot manufacturer KUKA. Sarkozy proposed the establishment of a European sovereign wealth fund to ensure that leading European companies that were suffering from depressed share prices would not be taken over by foreign state-owned funds.93
Countries also resorted to old-fashioned trade protectionism. The World Bank published a report on March 2, 2009, showing that seventeen of the nineteen developing and industrial nations (plus the EU) had introduced restrictive trade practices, despite pledging repeatedly at international meetings to avoid protectionism. The St. Gallen think tank Global Trade Alert published details on the large number of harmful trade measures, which rose year by year to 2013: the largest category lay in subsidies, but there were also many straightforward tariff increases.94
As old-style globalization, in financial services and trade, receded after the Global Financial Crisis, a new type of globalization took its place. Electronic communications continued to rise, and indeed the pace became more rather than less intense. The years of financial crisis were also the age of major innovation. The iPhone was unveiled in 2007; it revolutionized personal interactions and consumer behavior, as well as the transmission of news. As Steve Jobs put it at the unveiling of the iPhone, it was “a leapfrog product that is way smarter than any mobile device has ever been and super-easy to use.”95 At the beginning, the most attention was given to the culture or the fun—the accessibility of music and entertainment—but the device was a commercial one, and it produced a revolution in financial access. That was evident even in much less sophisticated mobile phones, which could be repurposed. M-Pesa (pesa is Swahili for money), the mobile phone–based money transfer and payments service, was launched in 2007 by Vodafone Group PLC and Safaricom, the largest mobile network operator in Kenya. So the world’s globalization shifted from trade and finance to data and communications; but that revolution would in turn affect how trade and financial services could be supplied. The crisis at the same time accelerated dramatically the rise of emerging markets, in particular China, and in some part that was the consequence of technology offering an easier way of catching up. Trade fell back while the weightless world of electronic interchange surged forward to much greater integration. Money could also be thought of as part of the weightless world, and one that central bankers were actively pushing.
Bernanke’s Remedies
Ben Bernanke is the first and only central banker to have been awarded the Nobel Prize in Economics. A southerner, born in Georgia in 1953, he grew up in the small town of Dillon, South Carolina (population 6,500). The son of a pharmacist and a mother from a deeply religious Jewish family, he was an exceptional scholar. The Great Depression left a traumatic scar on his family: the U.S. Depression hit his grand father, an immigrant from the Austro-Hungarian Empire, Jonas Bernanke, who worked as a pharmacist in New York and then moved to South Carolina to escape from the big city of the Depression era. There the business succeeded, and his son, Ben’s father, continued the family business. Ben’s maternal grandparents fled Nazi and Croat fascist persecution, first to Italy, then to the United States. His family background might make it unsurprising that he worked for a very long period of time on understanding the Great Depression, the catastrophe that destroyed the U.S. economy and pushed Europe’s slide into barbarity, racial persecution, and violence.
Bernanke did not intend to become an economist when he began at Harvard, and took an introductory economics class taught by Martin Feldstein rather haphazardly, but then realized that economics was a way of combining his interests in math and history. He went on to the Ph.D. program at MIT, studied with Stanley Fischer, and read Milton Friedman and Anna Schwartz’s Monetary History of the United States, the analysis of which focused on the U.S. Great Depression. Bernanke was never a Friedmanite, but regarded himself as part of the broad New Keynesian movement which provided what he saw as “the best framework for practical policymaking.”96 His work on the interwar Depression modified Friedman’s lessons in an important way, moving away from the unrealistic assumption that Fed-controlled base money was the principal driver of the U.S. plunge into the Great Depression. Friedman and Schwartz had looked at the collapse of the money stock and renamed the Depression the “Great Contraction,” but they had not penetrated into the way that banking lending and credit decisions were made. Bernanke was thus filling an important gap in Friedman’s argument. His critics sometimes derisively dismissed this theory as “creditism,” but his work pointed to how important an understanding of the institutional mechanisms that create money would be for any policy application.97
One way of presenting his theoretic innovation was through discussion of a “financial accelerator.” This is a mechanism familiar to many historians: apparently small-scale events can produce worldwide effects. This is Ian Goldin’s “butterfly defect.” It used to be conventional to point to debates about how the shape of Cleopatra’s nose influenced history: it led Mark Antony to abandon Rome for Egypt, and thus made possible the establishment of the Roman Empire by Octavius Caesar. There is an economic-history counterpart: relatively small impulses or disturbances can cause large fluctuations in aggregate economic activity. But then there is an interest in identifying the linking mechanism that might drive causation and lead to big consequences from a small event: there needs to be rather more than an exploration of the anatomy of the queen of Egypt’s nasal cavities.
Bernanke, together with his long-standing coauthor, NYU professor Mark Gertler, developed an approach that looked at the effects of imperfect information in finance through a concept of agency costs, the operations needed to assess the value of a particular enterprise or individual in order to commence a lending operation. In an economic downturn, uncertainty and fear of bankruptcy increase. Potential borrowers who face significant costs of borrowing—consumers and small firms, for example, or firms with weak balance sheets—will see those costs rise and may thus be excluded from borrowing, or only be able to borrow on much harsher terms. As Bernanke and Gertler put it: “To the extent that negative shocks to the economy reduce the net worth of borrowers (or positive shocks increase net worth), the spending and production effects of the initial shock will be amplified.” The “debt overhang leads to the possibility of a low-output expectational equilibrium.”98 Sometimes it is helpful for noneconomists to imagine a practical example: a pharmacy in the Great Depression, such as that operated by Jonas Bernanke, would find it harder to borrow because the risk of bankruptcy was assessed higher by potential lenders. As an result, he could not hold so much stock. The store consequently appeared less attractive and lost customers. The possibility of bankruptcy, weighed up by the bankers, could thus become a reality. This was a logic that had been influentially analyzed by Irving Fisher, a major figure in the development of the quantity theory of money, who termed the process debt-deflation.99 Bernanke built the insight into a formal model.
