Martin Wolf has answered these questions in a series of blog posts on the Financial Times website over the last few weeks that explore one of the defining economic issues of our time: deleveraging.
The series started on July 10 with Wolf’s FT op-ed, “We still have that sinking feeling.” In it, Wolf criticizes the Bank of International Settlements (BIS) for its call for monetary and fiscal tightening in high-income countries. Wolf suggests that this recommendation doesn’t deal with the reality of large-scale private sector deleveraging, which demands the opposite approach from what the BIS recommends. “The heart of the matter is accelerating de-leveraging, while promoting recovery,” he writes. And the BIS plan doesn’t get there.
Picking up from there, Wolf writes about “Debt, deleveraging and crisis in the US.” He pores over the debt-related charts and data for the U.S. economy, showing “the extraordinary nature of the credit boom in these years and the scale of the recent collapse.” In particular, he demonstrates the collapse in private sector borrowing since the 2008 financial crisis. “In 2007, gross borrowing in credit markets was running at 28 per cent of GDP,” he writes. But “in 2009, this had turned into minus 17 per cent.” In light of this collapse, even the U.S.’s minimal counter-cyclical fiscal policy was significant. “There is absolutely no doubt what would have happened if the government had been unwilling to borrow when borrowing by the private sector collapsed,” he writes. “We would have seen a huge depression. Fortunately, that did not happen.”
The story, he suggests, is clear: “Massive increases in private debt fuelled, of course, by a huge expansion in borrowing (and lending), occurred in the decades prior to 2007, when debt reached a peak. The turn-around in borrowing in the crisis was both swift and brutal. But the collapse of private borrowing was offset, at least in part, by additional government borrowing.” This evidence flies in the face of the “austerians,” who argue for fiscal tightening.
In the second part of his blog series, Wolf continues his focus on the U.S., with the help of Richard Koo’s famous work on balance-sheet recessions. He explains how sectoral balances (those between the private and public sectors) must sum to zero, so that when the private sector is saving and deleveraging, the public sector must be running a deficit. The virtue of this framework, Wolf suggests, is that “it forces us to ask what drives what: are, for example, fiscal deficits in the U.S. (or U.K.) driving the surpluses in other sectors or are the surpluses in the other sectors driving the fiscal deficit?” He looks at the U.S. historical data from the 1990’s and 2000’s, which show that “the government’s position has been the mirror image” of the private sector’s.
The data show that in the corporate sector “the financial balance of the private sector shifted towards surplus by the almost unbelievable cumulative total of 11.2 per cent of gross domestic product between the third quarter of 2007 and the second quarter of 2009.” The results were even more dramatic in housing. And as a result, the government deficit exploded.
Wolf extrapolates from this data to suggest that the usual story of government decisions determining the economy no longer makes sense. “The overall story,” he writes, “is of an economy driven not by fiscal policy decisions, but by private sector decisions taken for reasons that have nothing to do with the long-run fiscal prospects of the economy. Meanwhile, the government, as a whole, was driven into huge deficit by these private sector decisions.”
In further posts, which INET will explore tomorrow, Wolf examines the rhetoric against fiscal support for deleveraging, including the notable work of Reinhart and Rogoff, and compares it to the data.