There are also concerns about slowing growth in the US and China and the early estimates of manufacturing activity in Europe for May were very weak. If growth is going to remain weak, the debt crisis will not be solved.
Lower borrowing costs
So what to do? Maybe policy makers should be a bit more macho, take a few risks. In the spirit of middle-aged men going to hip-hop concerts (Yes, I Was at the Jay-Z and Kanye West concert in London last week…) let’s think a little crazy here. After all, for the UK, US, Germany and Japan, the markets are providing a potential opportunity by showing a willingness to fund those governments at negative real interest rates. These core governments can borrow at much longer maturities and much lower yields than the troubled countries of southern Europe.
This means that future tax payers are getting something of a windfall from lower future debt service costs. If yields are below nominal GDP growth the debt dynamics are manageable. Of course, borrowing to boost growth when the policy debate has been framed by deficit reduction seems somewhat counter intuitive, but if growth is higher then the net benefit to the economy will be worth it, even if borrowing costs rise over time as a result.
Quantitative easing has kept yields low, but there is little evidence of this policy boosting aggregate demand, largely because the banking system is in retrenchment mode and isn’t lending. So the banking system needs to be circumvented somehow. It would be much better if the money could somehow get directly to consumers and businesses. So why not cut taxes and finance that by borrowing in the gilt market at very low yields.
There may be an up-front hit to the deficit and debt numbers, but there could also be increased confidence, stronger consumption spending and a pick-up in employment. More employment in turn generates higher tax revenue and lower unemployment benefit and other welfare costs. Taxes to be cut could either be income taxes or VAT.
Lower business taxes
On the business side the key seems to be a lack of confidence in the outlook and the high cost of regulation. Further reductions in corporate taxes or employer national insurance contribution and enhanced tax deductions for job-generating investment projects could be considered. The cost could be borne by the deficit and financed by the willingness of the markets to buy AAA gilts, especially if the Bank of England continues with QE.
At the moment the rich are getting richer and the poor are getting poorer. Low bond yields in the core economies are reducing the future debt service burden for the tax payers of those countries, while high bond yields in weaker economies are raising the debt service burden for future tax payers in those economies. At the same time austerity is more severe in the peripheral economies as they have had to promise to reduce deficits by huge amounts quickly, while the US, UK and Japan are barely reducing their deficits at all over the next couple of years,according to most forecasts.
Growth is much weaker in southern Europe than it is in the north or the continent, and much weaker in Europe as a whole than in North America and Asia. What I am suggesting may be irresponsible. It could backfire as bond vigilantes might take fright at the thought of even higher deficits in the UK and US. Yet if combined with the kind of supply-side reforms that are clearly needed to make it easier to employ people and for consumers to retain (and potentially spend) more of their earned income the benefits could be moreg rowth and a much healthier longer-term fiscal balance.
We are not going to get out of this mess by a return to credit-led spending on housing as was the case in the 20-years before 2008. Nor are we going to get out of it by just providing sufficient liquidity to allow a globally bloated banking system to deleverage.
Proactively uses of capital
The fact that bond yields are low indicates that there is a lot of excess capital available in the world but it is not being put to use in a productive way. We need to think of ways to use that capital to promote growth and employment by removing barriers to consumption and investment and allowing the return on private capital to increase again through higher rates of economic growth.
Yes, ultimately that will mean higher bond yields but it might also mean better returns on equity and, more importantly, a less bleak outlook for today’s young people than the one currently confronting them. Will any politicians be brave enough to start thinking in these terms? I somehow doubt it. The best we can hope for is that the Greek situation leads to some policy big bang and an acceleration of closer fiscal integration in the eurozone.
There could be plans for more co-ordinated capital injections for European banks, for European bank regulation and deposit insurance. The ECB could provide more liquidity. The resources of the ESM could be mobilised to help stressed sovereign borrowers. Infrastructure projects could be developed. All these would be welcome, but would they create sustainable growth when what many western economies suffer from isthe lack of support for private entrepreneurship?
Jay-Z came from a broken home in a housing project in Brooklyn and is now reported to have a personal fortune of over $450m – if only some of today’s politicians had the same kind of drive to succeed and the imagination and desire to create economic wealth!
