A World at Risk

My last day as President of the Federal Reserve Bank of Minneapolis was on December 31, 2015.  I began blogging on January 2, 2016 (the day after arriving in my new home town of Rochester, NY).  In my first post, I wrote that “economic policymakers can do better.  Indeed, I increasingly believe that they must do better.”  In my view, the global political events of 2016 show why I wrote those words.

That first post argued that macroeconomic policy remained much too tight around the developed world.  It closed with the following warning and admonition:

“We are only beginning to see the impact of tight policy choices on our economies …  Given these kinds of macroeconomic outcomes, it should not be surprising that we see increasing signs of social fracturing and disengagement in many developed countries.”

The process of “social fracturing and disengagement” to which I referred continued apace in 2016.   In the UK, Britons voted to break away from the European Union.  In the US, a political outsider used a platform of economic isolationism to defeat a string of establishment candidates from both major parties.  

There will be elections in France and Germany in 2017.  I expect large, and possibly decisive, repudiations of the political establishment in both votes. 

Will policymakers begin to engage in the kind of fiscal/monetary easing that is needed to heal our economies and our societies?  Possibly – there is talk from the incoming American administration of increases in government spending and tax cuts. But many elected officials (and professional economists) have also expressed strong opposition to these policy choices. 

Those opponents should bear in mind that there are grave risks associated with overly tight macroeconomic policy and the accompanying shortfall of aggregate demand.  As I wrote on January 8 of this year,

Much of the world experienced a significant global demand shortfall throughout the 1930s … It is true that if we fast forward to 1950, the demand shortfall had been largely cured.  Unfortunately, I suspect that the destruction associated with World War II was an important part of the “solution”.  During the course of that War, over 50 million people were killed, and many others were injured severely.  Much of the physical capital of Asia and Europe had been destroyed.  The world didn’t put [its] “idle men and machines” to work - it destroyed them instead … the experience of the 1930s and 1940s is unfortunately suggestive of how the economic pressures of a global demand shortfall can give rise to highly adverse geo-political outcomes.”

Unfortunately, I see many more signs to support the possibility of “adverse geo-political outcomes” (to use my euphemism) than I did in early 2016.  

So, as we enter 2017, the world needs easier fiscal and monetary policy in the form of more government debt, lower taxes (especially on investment), more infrastructure and lower interest rates.  But this prescription has been the right one for at least eight years.  We can only hope that we have not left the problem unattended for too long.  

N. Kocherlakota
Rochester, NY
December 30, 2016

Follow me @kocherlakota009.