The economic road back to normal

The sooner we complete private deleveraging, refinance public debt, and return to traditional fiscal (rather than monetary) policy, the better off we all will be


On top of admonitions that recoveries from credit crises were different from other recoveries, they drew on historical data to suggest that housing prices can drop by a third and stock markets could get cut in half. Photo: Bloomberg
On top of admonitions that recoveries from credit crises were different from other recoveries, they drew on historical data to suggest that housing prices can drop by a third and stock markets could get cut in half. Photo: Bloomberg

In light of the big rise in the June payrolls in the US, I wanted to offer some broader context about the American economy. Understanding the swings of data might change the way you perceive the financial markets.

First, the set-up: It would be an understatement to say there was lots of nervousness after the credit crisis and Great Recession of 2007-2009. The wounds may have been self-inflicted, but they were deep and painful. How quickly the economy would recover from the combination of huge debt expansion, the wave of foreclosures and spiking unemployment was a major unknown.

After the recession ended, many economists were looking at this the wrong way. They should have been focusing on the pile-up of debt. Instead, they assumed this was an ordinary recovery from a recession, and that the deep plunge in the economy would be followed by a rapid snapback. That didn’t happen, and that has led to much angst as the recovery proceeded fitfully and at a pace well below that of average recoveries in the post-war era.

My Bloomberg View colleague and former head of Pacific Investment Management Co., Mohamed A. El-Erian, is credited with coining the term “new normal”. In a speech he presented in 2010 to the International Monetary Fund, “Navigating the New Normal in Industrial Countries”, El-Erian described what changed, “We coined the term ‘new normal’ at Pimco in early 2009 in the context of cautioning against the prevailing (and dominant) market and policy view that post crisis industrial economies would revert to their most recent means. Instead, our research suggested that economic (as opposed to financial) normalization would be much more complex and uncertain—thus the two-part analogy of an uneven journey and a new destination.”

That seems now to have become the prevailing view among many members of the dismal profession. But not all economists were caught unawares by the Great Recession and its aftermath. Carmen M. Reinhart and Kenneth S. Rogoff created a different framework for looking at the recovery, using data to establish how rebounds from credit crises were unlike recoveries from normal recessions. And they figured this out before the scope of the financial crisis was clear to most people. In January 2008, they published a paper titled Is the 2007 US Sub-Prime Financial Crisis So Different? An International Historical Comparison. They warned that the US subprime mortgage issue was turning into a full-blown credit crisis, not just a typical recession. They repeated their warnings that the debt overhang would impede growth until a thorough deleveraging had occurred.

On top of admonitions that recoveries from credit crises were different from other recoveries, they drew on historical data to suggest that housing prices can drop by a third and stock markets could get cut in half. With the US stock markets setting record highs only a few months earlier, this analysis was received with scepticism by many.

All of which leads to the past two monthly jobs reports. May was a huge negative surprise, which was offset by an upside surprise for June. Each report seemed to be followed by corresponding —and no doubt incorrect—assumptions about what this meant for the economy, stock markets and US Federal Reserve rate increases.

The US continues to be in a post-credit-crisis recovery—that means more deleveraging is to come and because of this, expect mediocre growth, job creation and retail sales for some time to come. The prescription is to replace monetary policy as a key economic stimulus with a robust fiscal policy, primarily focused on infrastructure. Fund it all with bonds that mature in 50 or 100 years to take advantage of record-low interest rates.

The huge debt overhang from cheap money and the absence of a traditional fiscal policy in the post-credit crisis period are really what the “new normal” has been. The sooner we complete private deleveraging, refinance public debt, and return to traditional fiscal (rather than monetary) policy, the better off we all will be. BLOOMBERG

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