Policymakers and asset prices: an even bigger moral hazard?

With earnest intent on the part of their organisers, many conferences were held in the immediate aftermath of the GFC, in an attempt to marry the analysis offered by both academic and (albeit only a few) practical economists, in the hope of producing a new approach to economics that might be better able to explain the perceived new world order. In our view, the output from many of these events ultimately was quite limited – in practice, many of the conferences were hijacked by the mainstream financial media - but, nevertheless, over the course of these events, two surprisingly popular books came to achieve a high level of prominence and we believe that they came to gain an overriding influence on policymaking over the last decade.

Specifically, the two policy recommendations that emerged were that asset prices should be supported by either direct or indirect policy actions in order to prevent ‘balance sheet recessions’ (although we might argue that it would have been better to have avoided debt-fueled booms in the first place that then required high asset prices to offset the debt that had been/was amassed), and the second recommendation was that public sector debt must be reduced (even while encouraging an increase in private sector indebtedness) through the use of politically-divisive austerity policies, even at times during which government bond yields were occupying record lows.

We would argue – very strongly, in fact – that these policy recommendations merely represent attempts to alleviate the symptoms of what are, at their root cause, supply-side failures. Had Japan’s authorities liberalised their supply side via the abolition of some planning controls and reduction in MITI’s overbearing influence on the economy, then a credit boom would not have been ‘needed’ in order to (artificially and only temporarily) depress Japan’s trade surplus during the 1980s. Without the credit boom, there would have been no build-up of debt liabilities in the economy that allowed balance sheets to become stressed. Similarly, supply-side deregulation that lifted productivity growth and hence tax receipts would have ‘cured’ governments’ fiscal problems, in much the same way as had occurred in the first half of the nineteenth century in the UK, or in the Clinton-era USA.

However, in part as a result of the perceived new ‘orthodoxy’ that emerged in the early 2010s, governments such as the UK’s Cameron-Osborne administration have consistently eschewed supply-side measures and focused almost exclusively on austerity/reductions in government spending while at the same time utilising QEPs (Quantitative Easing Programs) and other related artificial policies that have been overtly designed to support asset prices, despite the inequalities in wealth that these policies have created (being an existing owner of assets has been ‘great’ over the last nine years, but if you were looking to buy, then the costs of houses, equities or bonds has seemed to be prohibitive in many cases).