Only three years after the world’s financial crisis in 2008, the global economy is slowing down again. At the start of the year, most forecasters expected global gross domestic product to expand in the range of 4.3 percent to 4.5 percent, it probably will only be around 3 percent.
While economic growth in many Asian and Latin American countries remains relatively strong, Western countries are hit much harder. Economic growth in Europe as well as the United States has slowed significantly in recent quarters, and it looks like many countries will experience little to no growth this and next year.
Even harder hit are the “problem” countries like Greece, Italy and Spain, just to name a few. Many of these nations have slipped back into an economic contraction, and negative growth will become even worse next year as the austerity measures in many of these countries will exacerbate the situation because governments are forced to cut spending. There is simply no easy way out of this challenge; Western nations have lived above their means for too long.
Since there is no easy solution for today’s problems, what can be done to manage and improve the situation in the future? Clearly, in a difficult situation like this, it takes a lot of hard work and a sound plan to restructure Western economies. It means that people from different political parties have to come together and work for the mutual benefit of a country. What bothers me about today’s situation is the fact that no one seems to be willing to listen or work together. This is very obvious in politics, where either that or this party claims to have the answer to today’s challenges.
Just think of the long fight between Democrats and Republicans about the increase of the debt ceiling. It was an almost endless discussion that, in the end, only hurt the American people. The real damage was done to the creditability of the United States as a country, in a time when foreign capital is needed more than ever before.
A similar fight currently takes place in economics. There is a big fight between so-called Keynesians (followers of economist John Maynard Keynes), typically liberal-minded economists and the Austrians (Austrian school of economics), a much more conservative-minded school of economics. Keynesian economics argues that private sector decisions sometimes lead to inefficient outcomes; therefore, the public sector needs to actively balance the economy. Austrians blame the Keynesians for today’s economic problems, because in their view there is simply too much money printing going on today and the government gets involved way too much. On the other hand, the Keynesians believe that in today’s situation, it is absolutely critical that governments keep spending money in an effort to balance the lack of economic growth in the private sector.
The long-term goal of the “Keynes” principle is to smooth out economic cycles by acting counter cyclical. When demand is low, increase spending. When demand is high, reduce spending. At first glance, that’s not a bad idea. However, today’s situation is different. Keynes’ model probably works in a more normal world, one in which governments are not already carrying such high levels of debt.
Most large central banks in the world today have a very expansionary monetary policy. This shows up in the fact that interest rates have been trending lower for many years and have now arrived at virtually zero. Also, central banks are providing extra liquidity to the financial system in different ways in order to ensure that the world financial system keeps properly functioning. The real problem with today’s situation is that the increased liquidity is not helping the economy. It’s not creating jobs or producing investments; therefore, it will not create any meaningful economic growth.
A central bank like the Federal Reserve in the United States or the European Central Bank can theoretically expand its balance significantly above today’s already inflated levels. It just means that more U.S. dollars and euros will get pumped into the system. Today, the main function this liquidity has is to calm the system and stabilize the banks. This money printing will weaken these currencies, which is already obvious with the U.S. dollar and the euro being among the worst performing currencies in recent years.
Money printing will create some inflationary forces that help stabilize the deflationary tendency coming from the slowing global economy. This inflationary impact will get stronger the more the currency depreciates. However, the real danger is that eventually, the economy picks up again and the incentive for the banks to lend money increases again. Then, a lot of excess liquidity in the system will find its way into the real economy. Typically, at such time, the velocity of money is increasing again, resulting in a strong increase of the monetary base. Unless a central bank acts very quickly and withdraws some of that excess liquidity, the consequences can be severe, creating asset bubbles and high levels of inflation, possibly hyperinflation.
The situation today is challenging for a number of reasons, and it’s certainly much more complex than many people think. That’s why I think this is not so much a matter of selecting the superior school of economics, but taking the strong points of each and combining them for a sound economic recovery plan. Unfortunately, the dilemma is that advocates of each school of economics often don’t respect the other’s approach.
The same is true in politics; that’s why we never get solutions. It’s not about change in general; it is about a change in the way we work together and communicate with each other. Republicans and Democrats in the United States, as well as other major political parties in other countries, often fight each other for the sake of fighting. They forget the fact that they all need to work for the benefit of the country and its people.
I don’t consider myself a follower of any school of economics, but I see that each has strong and weak points. There are certainly some principles which are generally applicable, but every economic problem is unique. In order to solve an economic problem, one needs to go beyond the limitations of certain frameworks. Applied to today’s difficult economic situation, it means the Western world needs to understand that it lived beyond its means for too long. Today’s welfare system is not sustainable. Generally, people are asking for too much from the government, and politicians have chronically overpromised for so many decades that the government simply can’t foot the bill anymore.
The solution to today’s economic and political changes is not about Keynesians vs. Austrians or Republicans vs. Democrats; it’s about working together for the best possible result for the country. What we need is more respect, especially respect for different views and opinions and a better sense of cooperation. This is what true leadership is all about, and this is how governments can regain people’s trust. Trust and increased confidence will eventually trigger investments and spending and get the economy going again. True leadership means respect and the ability to listen to other opinions and acknowledge the value of true cooperation.