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The Contradictions of Global Fiscal-Monetary Policy


“QEs, massive liquidity injections by central banks, token fiscal stimulus policies followed soon by austerity fiscal stimulus withdrawals represent the recovery policy ‘mix’ for the US since 2008.  In similar form, albeit with different emphases, the same monetary and fiscal policies have been adopted by other main capitalist sectors of the global economy. Those economies, from the Eurozone, UK, to Japan and elsewhere are also experiencing a ‘stop-go’ economic recovery trajectory.  The outcome has been more or less the same everywhere: a bailing out of the banks, an acceleration of investors income and corporate profits, a shift toward speculative financial investment, growing income inequality, declining relative real investment, inability to generate full time employment and wages, declining real disposable incomes for median family households, stalling consumption, and a sub-par historical, ‘stop-go’ economic recovery.  

The US driven policy package of QE-unlimited liquidity, plus token fiscal stimulus followed by austerity and initial stimulus withdrawal, has been converging across all the capitalist economic sectors globally. All sectors, with perhaps the exception of China, have been following the US fiscal-monetary policy lead. This has been especially so with regard to QE and monetary policy which has been the main policy level of choice for capitalist economies and governments worldwide since 2008. 

But fiscal-monetary policies globally are not only failing to generate a normal, sustained economic recovery; they are now also beginning to have a contradictory, counter-productive economic impact.

The growing contradictions in monetary policy are several. 

First, it is clear that after five years of QE, investors are becoming addicted to QE and virtually interest free money from the Fed and central banks. When the Fed attempted to signal a future withdrawal from QE this past June, financial markets reacted severely. In a matter of weeks, stocks, bonds and financial asset prices plummeted and interest rates rose quickly. The Fed then backed off, re-signaled again in August, with the same response. It may prove significantly difficult for the Fed, and other central banks, to begin suspending QE and withdrawing liquidity without interest rates rising rapidly and provoking a serious real economic contraction.  At the same time, continuing liquidity and low rates has a decreasing positive effect on the real economy.

Second, it appears the capitalist economies are becoming increasingly interest rate increase sensitive as they have become interest rate decrease insensitive.

Third, the continuation of massive liquidity injections via QE and other means has begun to exacerbate currency wars.  One sector engages in QE, driving down its currency’s value, lowering in turn the cost of its exports at the expense of competitors.  Others then respond similarly. Currency volatility results across the board, which creates uncertainty for real investment. Economies subsequently slow. What was competitive devaluations during the great depression of the 1930s via declaration, now occurs via currency exchange rate movements via QE and liquidity.  

Efforts by the Fed and other central banks to withdraw from QE result in massive capital flight from emerging markets, as hot money that was pushed into those markets when QE was growing now sloshes back to the US and Europe when liquidity is reversed. Capital flight from emerging markets forces those economies to raise interest rates to lure back the capital, but doing so slows their real economies that causes even more capital to flow out of emerging markets. The process destabilizes the global financial system in turn.

QE and excess liquidity spills out in global financial markets. Far more money capital is available that can be profitably invested in real production. Investors turn to short-term financial asset investments. Speculative investing and financial asset prices and profits rise, drawing capital from real asset investment into financial assets.  Capital flows increase in magnitude and frequency across countries, destabilizing the global financial system still further. 

Not least, as already noted, the accelerating financialization of the global economy provoked by QE and unlimited liquidity injections by central banks leads to accelerating financial profits, income, and wealth by investor households that in turn results in growing income inequality and problems sustaining non-investor household consumption. 

To summarize, monetary policies since 2008 are breeding dependency on free money from central banks, super-sensitivity to interest rate hikes, currency wars, competitive devaluations by means of exchange rate volatility, capital flight from emerging markets, excessive speculative investing and declining real investment that slows the real economy making it difficult to create jobs, reduce unemployment and sustain household consumption, and in general exacerbate hot money flows globally that destabilize the global financial system. 

Contradictions in Fiscal Policy are no less significant. 

Fiscal policies are also becoming less effective in generating real economic growth. Contrary to what liberal economists argue, deficit spending per se does not stimulate economic growth.  The composition of that spending is key, not just its magnitude (business tax cuts vs. direct spending by government). Business tax cuts don’t create many jobs any longer since, in a global economy, they are easily diverted offshore or into financial investments by corporations today; or used to buy back stocks, pay dividends, retire debt; or just hoarded as retained earnings in offshore tax havens or in companies’ foreign subsidiaries. What economists refer to as tax multipliers have thus declined significantly in the 21st century global capitalist world, rendering fiscal stimulus policies less effective. 

Not just tax multipliers, but government spending on subsidies to states, rather than on direct federal job creation, results in a smaller multiplier effect than in the past, producing fewer jobs as state and local governments, like corporations, don’t hire but pay down debt or hoard cash. Conversely, government deficit spending cuts and austerity fiscal policies have a larger negative multiplier effect, as government entities prefer to lay off workers and reduce spending on programs in lieu of committing cash to spending.

A further reason why multiplier effects have declined is household consumers have become more ‘fragile’—that is, they have accumulated excessive debt loads and face stagnating or declining income gains. Government spending and tax cuts targeting consumer households thus get diverted to retiring debt or paying for inflationary increases for essential goods and services that was once covered by rising wage incomes.  

To summarize with regard to fiscal and austerity policy, government spending and tax cuts no longer have the same positive effect on economic recovery they once had. Greater household debt and stagnating incomes reduces the effect of fiscal stimulus. That same debt and income stagnation makes austerity fiscal policies in turn more effective in terms of reducing consumption. Austerity multipliers are greater, while fiscal stimulus multipliers are smaller. Austerity serves to contract the economy, but does so more effectively than tax cuts and spending stimulate the economy. In order for fiscal stimulus policies to return to past effective levels, major structural changes will have to occur in the economy: incomes will have to be redistributed from the wealthiest households and toward the middle and working classes by means of a number of measures, while debt levels will have to be reduced or debt expunged.

(The complete article, ‘The Slowing Global Economy’, with accompanying graphs and charts, is available in the November 2013 issue of ‘Z’ magazine). 

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