Why it’s not an economic crisis

We double Foreign Policeof the magazine’s summer 2022 issue “Back to the Future” because key aspects of world affairs seem to be echoes of the past: fears of nuclear war, great power politics, a new arms race, the return of non-alignment, a food shortage, and so many other things.

In one of the magazine’s essays, FP columnist Adam Tooze considers that inflation has returned to what it was in the 1970s. Although the comparison is in itself a no-brainer, Tooze writes that policy makers should not rely too much on the lessons of this period.

I spoke with Tooze in an FP Live interview marking the release of PFprinting problem. You can watch the full discussion in the video below. The following is a condensed and edited transcript.

Foreign Police: Why do you think some of the lessons we learned from the 1970s don’t exactly apply today?

Adam Tooze: I think you could look at it and say superficially, “There is a war. There are blockages in the global energy supply system; there is a food price crisis. All of these things frankly look like 1973, that’s the last time we saw this kind of setup. But what sustains inflation over the long term, over the entire decade of the 1970s, is something that really went beyond this framework: the class struggle. It has to do with class forces and the balance of power between organized labour, unions and employers, and governments around the world in the 1970s.

PF: Are the people asking for a welfare state?

TO: Yes, more public spending and higher wages and negotiations between unions and employers on how prices and wages will be set – what has been called liberal corporatism. As a result, you grant interest groups key levers of economic policy. And that is the crux of what the crisis of the 1970s was: the fear among many elites around the world of losing control of this battle for the whole apparatus of what we have now come to call neoliberal governance that took shape in the 1980s and 1990s. And that has long-term consequences. Inequality is rising in both the UK and the US, which are the paradigmatic examples of this type of policy from the 1980s. And even though we now have rapid inflation in the US and the UK , we also saw a decline in real wages. And this is hardly surprising because the structure of collective organization – of workers, of unions, the ability to counterbalance and repel – is extremely reduced compared to what it was in the 1970s. Symptomatically, one could say that the current moment resembles in some respects the previous decade. But if you dig into the social structure, it is radically altered.

PF: There’s a part in the essay where you write that “the radical energy of the first Biden administration has largely dissipated.” I read a touch of regret there.

TO: Yeah. I mean, I identify as a left-liberal, and there are a number of structural changes that need to be made in the United States if the 21st century isn’t going to be catastrophic, not just for disadvantaged groups, but for American society as a whole. I do not believe that American society can continue to function as I would like without, for example, adequate family protection devices. We need a device that allows young American families to survive and prosper and raise their children much better than they do because otherwise it has catastrophic consequences for society. Every country in Europe offers more generous support for young families than the United States.

The Biden program had three prongs, didn’t it? It was climate and infrastructure plus jobs and family welfare. And who died in the last 18 months. So yes, absolutely. It’s not just a matter of regret. I think it’s a tragedy.

PF: Much of what we discuss here is mired in politics and polarization. But the other aspect of economic policy is monetary, controlled by central bankers. Have Western central bankers so far approached the current economic crisis in the right way?

TO: I would hesitate to describe our current situation — again — as a crisis. There was a crisis in 2020 during the COVID shock, and it was the most savage, fastest, most dramatic and most comprehensive economic shock the world has ever seen. And then, what we have deliberately designed is the fastest recovery after such a crisis. What we are witnessing today is not a crisis, but the fastest growth slowdown we have seen in eight years.

PF: Thanks for saying that. Maybe I’m channeling popular discontent with inflation, but you’re right, it’s not a crisis.

TO: It’s not a crisis. America currently has full employment by any conventional standard. But you’re absolutely right, if you conduct opinion polls with the American public right now — especially if you take those who are predisposed to be hostile to the Biden administration — they will be convinced that America is in recession. It is a counterfactual. I mean, that’s a remarkable statement. America may slide into a recession.

PF: I think people often confuse downturns with recessions, which are, of course, two consecutive quarters of negative growth.

TO: Yes, of course, what they are experiencing, which is very real, is a cost of living shock the likes of which has not been felt in a long time. What they are experiencing is a decline in real wages. And people feel that, and it’s a real pain. It is a very serious situation, no doubt. It’s just not a recession or a crisis at this point.

We currently don’t have much risk of financial system implosion as we saw in 2008. Why do we know that? This can be inferred from the fact that central banks push up interest rates. If they thought there was a real risk of a financial crisis, that is, of bankrupt financial institutions, they would not do so. The [U.S. Federal Reserve] raises rates because they see the problem of inflation. They feel they need to be seen to do something. This may very well cause a slowdown. It’s already the case. And that could produce a recession, but that would be normal in terms of keeping inflation under control relatively quickly. It’s not unusual to have a recession, but since a recession is technically defined as two quarters of negative growth, and negative growth is rarely significant, we still expect 2023 to be a year of overall average growth. , but at a slower pace.

We are quite far from a crisis. This is best described as a slowdown.

PF: So far, much of our discussion has focused on wealthy Western countries. What about countries in the Global South, where central bankers have less agency to begin with? Inflation tends to be higher anyway, so when it rises it bites harder and can become rampant more easily. I am thinking of countries like Sri Lanka, Pakistan, Egypt, but also Argentina and Turkey. How do these countries manage a period of high inflation?

TO: Yes. I mean, they’ll be advised to do a lot of the same things. Their central banks will raise interest rates. They could try a fiscal tightening. But the problem in countries of the type we are talking about now is that they have very large populations. And in the face of the rising cost of living, one of the things governments will try to do, quite sensibly I think, is to freeze or subsidize prices. The government budget absorbs the difference, and this then produces deficits, which produces pressure on the budgetary plan. And that’s where the tough compromises really begin.

The other shock that these countries will suffer is that of the exchange rate. Sri Lanka, for example, imports almost all of its fossil fuels. As the currency devalues, the cost of these increases because you pay a higher price in local currency for your foreign currency imports. And it’s the cycles that are really destabilizing.

There are certain advantages, of course, to devaluing your currency. Turkey is a good example because it has a strong export sector. So, as the pound goes down, their exports go up, and there is a compensating gain in terms of employment and, therefore, standard of living for people who work in this sector. It is therefore not all losses due to this type of process, but it is very painful, and even more so in societies with smaller cushions.

PF: I have a subscriber question for you. Glenn C. asks if “expected inflation” is a major driver of future inflation, how can we predict future inflation?

TO: One of the things we learned in the 1970s is that if you’re managing inflation, what matters even more is managing what economists call the “actors”. In other words, companies, unions, people who make decisions in the economy, what they expect from the future. Because depending on that they will raise their prices or try to raise their salaries. If you anticipate inflation and don’t raise your wages, you’re basically writing a big L on your forehead and saying, “I’m going to be a loser.”

So when central bankers say they are responsible for controlling inflation, it is literally true that the most important thing they are responsible for is controlling inflationary expectations.

And one of the reasons I think this is a “keep calm and carry on” type moment is that we haven’t seen any panic in the bond markets. If bond market participants thought there was a real risk that we were going back to the 1970s, bonds would be priced very differently than they are now. But what we haven’t seen is the kind of tremor that suggests 5-10% inflation for the next 10 years. It’s just not there.

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