Just as we thought our worries from the last crisis was over, there have been multiple warning signs that the next one is imminent; inverted yield curves, eurozone slowdown, static low interest rates, and even the creation of instruments such as CLOs (collateralised loan obligation) which are being paralleled with the same toxic CDOs that caused our last crash are sparking concern amongst investors and policy makers. However, given the low long-term interest rate environment we are in now, governments and central banks will have to use alternatives out of their policy toolkits compared with after 2008.
The ‘conventional’ post crisis policy is mostly on the monetary side, particularly regarding cutting interest rates. The theory being that low borrowing rates encourages spending by consumers and investors in the economy. Then came quantitative easing (QE): the printing of virtual money whereby the central bank purchases government bonds to provide financial institutions with liquidity, which raises investment. Before the 2008 crisis, central banks set rates 5.25% across these three central banks. So when the crisis hit in ’08, there was much more room for monetary stimulus than compared with today, where interest rates are 0.75% in the U
K, and have entered negative territory of -0.5% in Europe. So what alternatives is there to policy makers?
Firstly, I would expect expansionary fiscal policy to have a much larger role. This involves lowering tax levels, and raising government spending. In 2008, the UK adopted an austerity policy, aimed at lowering the fiscal deficit to GDP ratio as a way of reinvigorating confidence levels. We witnessed VAT rises from 17.5% to 20%, and deficit levels dropping from £147.3 billion in 2010 to £32.3 billion in 2018 (a fall in deficit to GDP ratio of 9.3% to 1.5%). This has been criticised, especially as it explains the recent productivity lag we see today. Perhaps policy that was used by the US after 2008 would be more suitable to economies faced with bounded influence on monetary policy.
Additionally, trade policies may play a key role in mitigating potential negative spiralling growth. Based on Ben Bernanke’s “enrich thy neighbour” theory, he suggests that low tariff policies are essential during periods of crisis, as economies need to encourage the exchange of goods at lower prices to boost spending. The US may look to reverse these tariff hikes on China as a method of driving down domestic prices and encouraging more exports to stimulate the economy. Economies may have to collaborate more with their trade, helping export-led growth for some, and for allowing low import prices to help consumption levels.