Last week brought another slew of disappointing figures from Europe and Japan, the weakest links in the world economy since the collapse of Lehman Brothers, despite the fact that the financial crisis originated in the US. But even in the US, Britain and China, where growth appeared to be accelerating before the summer, the latest statisticsdisappointing retail sales in the US, the weakest wage figures on record in Britain and the biggest decline in credit in China since 2009suggested that the recovery may be running out of steam.
As Stanley Fischer, the new vice-chairman of the Federal Reserve Board, lamented on August 11 in his first major policy speech: Year after year, we have had to explain from mid-year onwards why the global growth rate has been lower than predicted as little as two quarters back This pattern of disappointment and downward revision sets up the first, and the basic, challenge on the list of issues policymakers face in moving ahead: restoring growth, if that is possible.
The central message of Fischers speechthat central bankers and governments should try even harder than they have in the past five years to support economic growthwas closely echoed by Mark Carney, the governor of the Bank of England, at his quarterly press conference two days later.
This consistency should not be surprising: Carney was Fischers student at the Massachusetts Institute of Technology in the 1970sas, even more significant, was Mario Draghi, president of the European Central Bank. Because of Fischers influence on other central bankers, as well as his unparalleled combination of academic and official experience, he is probably now the worlds most influential economist.
When US President Barack Obama appointed him vice chairman of the Federal Reserve, Fischer was widely viewed as more hawkish than Chairwoman Janet Yellen. He was considered a restraining influence on her instinct to focus on jobs and growth rather than inflation control.
So investors and business leaders should pay attention when Fischer makes his first major speech a call for more explicitly growth-oriented monetary policiesa call that other central bankers are already heeding.
Carney made this clear when he surprised financial markets by revealing no hint of anxiety about inflation or financial bubbles. He instead reiterated the Bank of Englands interest rate policy of lower for longer than almost anyone expects. To the chagrin of currency traders, who had been buying sterling on the assumption that Britain would be the first major economy to raise interest ratesperhaps as early as this year.
Even at the European Central Bank, the once taboo idea that monetary policy can be used to stimulate growth is suddenly open for discussionif not yet conventional wisdom.
Draghi, in his recent policy statements, has unequivocally promised that the European Central Bank would keep interest rates at zero far longer than the Fed and has openly welcomed the weaker euro this policy should produce. There has also been no criticism for this ultra-dovish policy from German Chancellor Angela Merkel or the Bundesbankif only because the German economy is reeling from the body-blow of the sanctions war with Russia and the violence in Ukraine.
But what of Fischers discouraging caveat at the end of his quote The challenge, he said, is restoring growth, if that is possible.
Many economists now say there is nothing more that policy can do to stimulate growth or employment, a view shared by many industrialists, financiers and politicians. Fischer is clearly not among these sceptics, and neither are the other leading central bankers.
Though official statements from leading policymakers are invariably hedged with qualifications, the gist of Fischers speech is clear: Restoring pre-crisis growth rates should be possiblebut only if economic policy is reformed to deal with three issues that have been treated as taboo, especially among central bankers:
First, central banks must be allowed to interpret their inflation targets flexibly, to ensure that monetary policy promotes growth, as well as maintaining stable prices. In support for European debtor nations that are wrestling with Germany over the ECBs exclusively inflation-fighting mandate, Fischer insists that in practice, even in countries where the central bank officially targets only inflation, monetary policymakers also aim to stabilise the real economy around some normal level or path.
Second, policymakers must distinguish weak demand, which is likely temporary, from weak supply-side growth, which may well be structural. This is essentially the issue discussed last month in this column. In the US, Fischer attributes the weakness of demand to housing, Europe and fiscal drag, and suggests that all these headwinds could be counteracted with better policies. Housing, for example, could be helped by avoiding a repeat of the sharp rise in mortgage rates in mid-2013. Reversing the drag from Europe requires resolution of the euro crisis. On fiscal policy, the obvious solution is simply to stop raising taxes or cutting public spending.
Third, Fischer points out that some of the supply-side obstacles to growth that seem structuralsuch as falling labour participation, low investment and weak productivitycan be caused by temporary weakness of demand rather than by permanent changes in technology or human nature.
A key objective of monetary policy is, in his view, to ensure that any temporary weakness of demand does not translate into a permanent reduction of supply by eroding work habits, discouraging investment and slowing productivity growth. There are real risks that cyclical slumps can become structural, Fischer said, and it may be possible to reverse or prevent declines from becoming permanent expansive macroeconomic policies.
As for the idea that productivity growth is permanently declining because technological ideas are near exhaustion, Fischer concludes wryly: It is unwise to underestimate human ingenuity.
It may also be unwise to underestimate the ingenuity of central bankersnow that they are really determined to get faster growth.
By Anatole Kaletsky