I talked yesterday about how the U.S. has been implementing its own austerity plan—by reducing federal and general government spending over the past couple of years—and how that has led to slower growth than would otherwise have been the case. Many would argue that this is nonsense, given the deficits we have been running, but a look at the stats from yesterday demonstrates that the government as a whole has in fact detracted from growth.
What has largely allowed this detraction to occur—while also allowing overall economic growth to continue—has been the Federal Reserve’s support of the financial markets and consumer spending by forcing down interest rates. You can certainly argue about how long the policy should continue or how damaging the exit will be—both questions I have addressed before—but, in my opinion, the idea that lower rates have allowed consumers to de-lever and supported the housing market recovery is beyond question.
Another way to evaluate the effects of the Fed’s actions is by looking at the rest of the world. Japan has been in a deflationary trap for the past 20 years. Just recently, the country decided to open the spigots for Fed-style quantitative easing on a massive scale—proportionately much larger than what the U.S. has done. So far, the results have been good; Japan just posted a relatively high growth rate for the past quarter, well above the previous quarter and also above estimates. The spike in growth was due largely to consumer spending and export increases driven by a weaker yen. Arguably, the Japanese economy is following the results in the U.S. after our QE.
The opposite of the U.S. has been Europe, where there has been fiscal contraction without monetary stimulus. Although there have been individual bailout deals, overall the European Central Bank has not provided the kind of general monetary support that the Fed and Japan have given. The result has been a sustained economic downturn, characterized today in the Wall Street Journal as the longest slump since WWII.
The fiscal contraction is at its worst in the peripheral economies, where both governmental and private demand have declined. The usual remedies, such as currency devaluation, have not been available directly, and indirect monetary support has been overruled. The only adjustment mechanism for these economies has been decreasing wages and employment. That process is still under way and in fact is migrating to other countries such as France, which remains in recession. Even Germany is slowing.
The question in Europe, beyond the politics, is what will change the current economic trajectory. Arguably, Europe is settling into a steady state of depressed economic activity. Of the four components—consumer spending, business investment, government, and net exports—none is well positioned to provide the kind of kick start that these economies need. In the absence of such a kick start, the depression is likely to continue.
The bottom line is that we now have several different examples of how economies work in a post-crisis environment. The U.S. is doing the best of any of the major economies and has implemented lots of QE even as fiscal stimulus has been withdrawn. Europe applied minimal stimulus, fiscal or monetary, and is trapped in a recession. Japan spent 20 years trying fiscal stimulus alone and now, after getting publicly serious over QE, seems to be improving.
None of this is to deny the problems associated with the exit that we will have to have. They will be serious. We will, however, be in a better position to cope with those problems than, say, Europe is. Japan has also apparently made that calculation.
The other part of this is that QE is not over. Today’s inflation results suggest that we are still too close to deflation for the Fed’s comfort, and, of course, unemployment is still too high. The end of monetary stimulus is coming but not in the immediate future. This is a good thing, as we need to buy some more time for the economy to strengthen further—which it seems to be doing.