You don’t have to be a greybeard to remember the Great Moderation. As recently as 2005, policymakers seemed to be able to keep recession away, inflation down and growth rates up. But now a new era—call it the Desperate Experiment—is well under way.
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It took a while to get going. The subprime crisis started to break in late 2006. But even on 14 March 2008, when the US Federal Reserve twisted its rules to help JPMorgan Chase and Co. rescue Bear Stearns, there was a great concern that governments should not get in the way of free markets. Such principled thinking allowed Lehman Brothers Holdings Inc. to collapse in a heap in September.
But since then, no policy has been too radical. The effective interest rate on central bank loans in every leading economy is close to zero. The Bank of England will try to manipulate the UK government bond market. The US Federal Reserve is buying up and guaranteeing private debts, and the European Central Bank could do something similar. Governments are taking over the system. Bailout programmes have put many of the biggest banks under official control. The US fiscal deficit—a shocking 14% of GDP in 2009, according to Deutsche Bank AG—will dominate the fixed-income market.
Collapsed: The Lehman Brothers headquarters in New York. Michael Nagle / Bloomberg
Why have such once sacrosanct principles as balanced budgets and freedom-to-fail been all but abandoned? To keep the recession from getting deeper. As yet, though, the radical therapy isn’t working. The news from the global economy isn’t all bad. Chinese business sentiment has bounced up, Germans are buying more cars and US retail sales increased in February. But at best, these might be signs of a slowing pace of decline. Unemployment is rising fast, credit spreads are widening and world trade has not picked up. The recession is getting worse. Unless a turn comes quickly, the official experiments are likely to get even more desperate. These could lead to a splendid recovery. But they could also cause severe adverse reactions. Investors are right to fear a variety of ills: falling stock markets, currency devaluations, depression, deflation and inflation.