On 9 August 2007, BNP Paribas halted withdrawals in three funds that had invested in subprime mortgages because the bank said it could no longer value its holdings of these assets. It was the one event that most agree marked the beginning of the Western financial crisis. Money markets froze in panic. The US Fed, European Central Bank and Bank of Japan led a coordinated response to infuse liquidity and calm some of the panic.
Four years later, the crisis continues. It has moved from the financial sector to government balance sheets. The convulsions seen in the financial markets over the past ten days are enough indication that four years of fiscal stimulus, rock-bottom interest rates and quantitative easing have prevented total economic collapse but been less successful in actually repairing the structural fault lines in the Western economies.
A recent graphic in the New York Times shows that various indicators of economic activity are still below where they were before the recession officially began in December 2007 - industrial production, non-farm payrolls, real personal income excluding transfers, average weekly hours of private sector employees and the gross domestic product. The only exception is real personal consumption expenditure, which is a slim 0.49% above its December 2007 levels.
The upshot: economic activity has not yet recovered to its pre-crisis levels. It’s no wonder that, after the Monday night sell-off on Wall Street, the Dow is around 20% below its level on 8 August 2007. Economists are already juggling with the nomenclature of what has happened in the past four years, saying the US could be headed for a Great Stagnation. The situation in Europe is not very different. The immediate risks may be of a double-dip recession, but the economic debate is now also trying to assess the probability of Japan-style stagnation.
The growing possibility of a Great Stagnation suggests that the problems cannot be tackled with the traditional tools of monetary and fiscal policy, which have any way been used to the utmost since the collapse of Lehman Brothers in September 2008. The US and Europe may need to ask hard questions about structural problems: the nature of the welfare state, the growth in entitlements in recent decades, the need to increase taxes on the rich, the role of the financial sector in Western economies, and much more.
It’s the sort of headlong assault on the established way of doing things that we saw in India in 1991 or in East Asia in 1997. Has the time for a fundamental rethink come in the US and Europe as well?
The Great Stagnation: is it here? Tell us at email@example.com