Forgotten lessons of 2008

Easy monetary conditions are a palliative, not a solution

There is much discussion on whether the post-pandemic recovery will be V- or U-shaped. A similar debate erupted after the 2008 financial crisis. This time around, the damage to the global economy is likely to be more significant.

The 2008 crisis affected mainly the financial systems of developed countries, where the combination of misguided regulation (markets know best) and pedantic monetary policy (inflation targeting and no ‘leaning against the wind’) created the perfect conditions for the financial storm that followed. In much of the rest of the world, while economies were affected by the upheaval in the developed countries, there was no crisis.

Consequently, when financial conditions in the developed world stabilised, economic activity resumed. However, in advanced economies, growth has remained weak, lowering the growth path for the rest of the world. It could be that pre-crisis growth was unsustainable, or equally, that the damage from the crisis weakened these economies more significantly than was recognised. A third possibility is that the main tool of macroeconomic policy was monetary policy, which is better at restraining demand than promoting it. A fourth factor could be that fundamental structural transformations have undermined growth, including technological change, misallocation of resources, high debt levels, worsening demographics, and wealth and income inequality.

The pandemic has spared few countries. This time, the impact on major financial systems, despite the substantial distortions, has been less significant, because the pre-emptive actions of central banks were targeted at avoiding financial disruptions. However, with the low and lower interest rates and the prodigious purchasing of private and public financial assets, the financial distortions are only getting worse, meaning that there will be no return to ‘normal’ monetary policy anytime soon.

The scope and depth of the damage to the real economy is more substantial than in 2008. Globally, unemployment, bankruptcies and the shedding of capacity have been far more significant. Despite large government support, especially to minimise the impact on employment, the damage will take much longer to reverse.

Lifestyle changes introduced during lockdowns may persist, fundamentally changing the way people work and live, and disrupting established patterns of economic activity. If the pandemic proves to be an event of economic catharsis, removing the inefficient and weaker businesses from the economy, the outcome will be more robust economies. However, while beneficial for long-term growth prospects, this will not alleviate the near- to medium-term economic pain.

There also seems to have been an evolution of thinking, at least politically, about the risks of globally dispersed supply chains. If such thinking actually manifests itself in the dismantling of a significant portion of existing supply chains, the disruption to the global economy will be significant and felt over many years.

Ultimately, the nature and quality of political and economic policy-making will determine if this event cleanses the economy and strengthens it, or burdens it even further and places it on a new unsustainable growth path. The quality of policies is critical given that the negative shock to the economy will be more severe both in terms of magnitude and duration, and will amplify unaddressed economic vulnerabilities. These include the high levels of overall indebtedness in the public and private sectors and the distortions in the financial markets. Easy monetary conditions are a palliative, not a solution.

Incidentally, when is a fiscal stimulus not a stimulus? When much of it gets diverted to politically-connected individuals and entities, or for payments to achieve political leverage, and only a relatively small amount reaches economically meaningful targets. It is when the stimulus becomes another opportunity for the looting of public funds. In such circumstances, a country’s overall debt burden increases but there is little impact on the momentum of economic growth. The presence of robust economic and financial governance is a necessary, though not sufficient, condition for effective stimulus.

I have a deep sense of foreboding that the flood of liquidity from central banks is submerging the fundamental economic problems under a sea of liquidity. This is making it more difficult to identify these issues, and reducing the incentives for policy-makers to immediately address them. However, if these challenges are not dealt with, they will continue to fester and undermine the health of the economy. This should have been the lesson of the 2008 financial crisis.

At no time in our recent history has there been a greater need for increased co-operation and coordinated policy action among the global community. Sadly, there seems to be little movement in that direction. The G7 and G20 economies do not see eye to eye and no longer display the leadership that is expected of them. We risk leaving crippled economies to the next generation.

Sukudhew (Sukhdave) Singh is a former Deputy Governor of Bank Negara Malaysia.

Join Today

Connect with our membership team

Scroll to Top