Central bankers, like military generals, are often accused of preparing to fight the last recession. The aftermath of the 2008 crisis was no exception. While huge, misplaced bets on subprime mortgages had triggered the crash, regulators concluded that its severity was due to banks holding almost all their assets in forms that could not be easily sold. When the subprime crash hit, this lack of cash meant that they stopped lending – to each other and the wider economy. As a result, Lehman Brothers collapsed and the global economy took its worst hit since the Great Depression. And so central bankers devoted the short term to getting banks lending again, and the long term to forcing them to hold more liquid assets.
The result is that the next financial crisis probably won’t look much like the last one. At the very least, it is significantly less likely to involve the failure of a systemically important bank. This is undoubtedly a good thing. But it also means that both markets and policymakers may respond very differently next time round.
What won’t happen?
Start with what won’t happen. In 2008, the drive to get banks lending again involved central bankers around the world coordinating their efforts to cut interest rates to record lows. Given the similar monetary policy environments in the UK, US and Eurozone, this meant that each could cut rates by more than 4% over the course of 2008-09. Today, the Federal Reserve would need to slash rates to -1.5% in order to achieve a similar effect. The same cut by the European Central Bank would take the deposit rate to -4.5%. In short, even in the context of unconventional monetary policy, a coordinated rate cut that was large enough to make a difference would be almost impossible.
Just as importantly, the last decade has seen the evaporation of much of the good will towards central bankers. Economists may largely agree that measures like quantitative easing and negative rates were successful at restarting global growth and preventing another depression. But what many people perceived was housing becoming unaffordable due to a QE-fuelled surge in asset prices, and inequality widening as austerity and unemployment paid for the mistakes of a few rich bankers, who mostly got richer. That mood has hardened in recent years and the politicians who encouraged it now enjoy more influence. As unelected technocrats – and, worst of all, “experts” – central bankers are unlikely to be allowed a blank cheque during the next crisis. Meanwhile, international cooperation is likely to be lower down the agenda.
Policy response in a populist world
So what might the policy response look like in a more populist world? First of all, unconventional moves might seem more palatable, so extremely negative interest rates could become a possibility again. In the UK, Jeremy Corbyn’s Labour Party has mooted going even further than quantitative easing with a “People’s QE” – essentially helicopter drops of money directly into citizens’ bank accounts. A particularly reckless government could even try the course of action recommended by many in 2008, of letting struggling companies simply go bankrupt en masse. But they should also remember that has been tried before, in the 1930s.
Of course, the obvious response to a crisis during an era where monetary policy is stretched to its limit is for governments to coordinate with their central banks on fiscal policy, to boost the effectiveness of both. And yet the political mood music in much of the world makes this seem unlikely. If a crisis occurs in the next five years, it is entirely possible that the White House will be occupied by Donald Trump, 10 Downing Street by Jeremy Corbyn or Boris Johnson, and the European Parliament by a greater number of nationalists than ever before. Those hoping for a joint approach may be disappointed.
By Joshua Roberts, Associate Director at JCRA