The post Global Financial Crisis (GFC) period has been a very challenging time for governments. Seven years on from the GFC and few countries have come close to achieving the levels of economic growth they had become accustomed to prior to the crisis. Most countries are more concerned about deflation rather than inflation as they try and find new ways to boost their economies while demonstrating financial prudence. With so much good intent, why is there so little success?
The first thing to understand is that the governments have relied on a few levers to control the economy over the last 50 years and those levers are no longer effective. The four main levers are: interest rates, quantitative easing, taxation, government spending. While many western governments have separation of treasury and governance, for the purpose of this article this distinction is moot and so we will simply refer to the overall grouping as government.
In a healthy economy these levers are used in combination to accelerate or slow the economy or to redirect economic activity. The most publicly recognisable lever is interest rates, which are raised to slow the economy, and lowered to accelerate it. In the post GFC shock, interest rates were lowered dramatically to try and prevent a major contraction in the economy. They have since been lowered further to try and stimulate the economy and at such low rates lowering them further can no longer be considered as an option to stimulate the economy.
The second lever is quantitative easing, which is creating more money (prior to the electronic age this was printing more money), and using it to payoff government debt, (retiring debt). This is intend to put more money into the economy which in turn should stimulate more economic activity. There has been an unprecedented level of quantitative easing over the last seven years, and as a result the world has never had so much money in circulation. For those unfamiliar with quantitative easing, it does have an opposite, quantitative tightening, which historically is removing money from circulation.
The third lever is taxation. Like the first two levers this can also go up and down. The benefit of this lever is that it can be more selective. Interest rates and Quantitative easing/tightening are indiscriminate. Taxation can be very pointed; directed at the rich or poor, and particular industries or economic activities, or at individual locations. Because of this, taxation is also much more political.
The other side of taxation is government spending. Like the other three levers this can also go up and down. Like taxation it can also be very specific in its application. Like taxation it can also be very political. As a general principal over the long term government spending should be in line with government revenue (primarily taxation). However in any given year spending can be less than revenue (surplus) or spending can be more than revenue (deficit).
In theory, using a combination of these four levers a government should be able to control the economy. To accelerate the economy they can lower interest rates and taxation, increase quantitative easing and government spending. This is exactly what governments have been doing for seven years and yet the economy still appears to be stalled – so why have governments lost control?
Simple really – all of these controls relate to money. Remember how money is a catalyst to trade? Well, when the quantity of a catalyst is in excess, the excess has no impact on the transaction. The world is awash with money, so it is no longer an effective lever for economic control.
What is actually required of governments now is the far more politically challenging task of redistribution of economic effort: using selective taxation and spending intelligently to positively position their economies for a better future in the new world order.