The Coming Crisis: stagflation and the shackles of market discipline

Jeremy Green - Honorary Research Fellow, SPERI, and Lecturer in Politics, University of Bristol

That the worst excesses of the 1930s were avoided was thanks, in part, to the lessons learned from the chastening experience of the Great Depression. Central banks unleashed the full force of their monetary ammunition in order to prop up financial markets and solidify the balance sheets of ailing banks.

What could not be avoided though, we can now see, was a new slow-burning crisis of stagflationary capitalism in the West. The ‘new normal’ of zero-bound and (more recently) negative interest rates alongside sustained monetary easing, has been allied with underwhelming growth performance. Collapse was avoided but the crisis came at the price of sustained and apparently intractable stagnation.

To contextualise this second stagflationary regime of Western capitalism, the one that began from 2009, we need to return not to the 1930s crisis, but to the stagflationary crisis of the 1970s, as an instructive parallel. The present macroeconomic malaise shares features with the first: low growth and prices stubbornly fixed around an extreme point of the continuum. But whereas the first stagflationary regime that unfolded in the 1970s was marked by the problem of high and sustained inflation, it is sustained global deflation that now threatens the stability of the global political economy.

The difference between these two stagflationary phases of post-war capitalism is partly a consequence of the divergent trajectories of oil prices within these two periods. During the first stagflationary regime, OPEC oil price hikes and geopolitical dynamics pushed up prices. Today, the profound collapse of prices in the global oil market has had deflationary effects.

This flies in the face of conventional economic logic, which suggests that the decline in the price of a key commodity such as oil should boost consumer demand and lower production costs in oil-importing markets, boosting growth. This tendency should be reinforced by ultra-low interest rates. So why do the Western political economies remain mired in stagnation?

That this has not occurred owes much to the lack of demand within Western political economies. As Larry Summers has outlined in his ‘secular stagnation thesis’– the efficacy of loose monetary policy as a demand stimulus appears to have reached its limits. Summers points to transformations in the structure of capitalism such as the emergence of new technologically oriented firms that reap large returns from minimum expenditure (for example, the social messaging firm WhatsApp), slowing demographic growth, and increased income inequality. All of these, he suggests, have led to a long-term structural decline in the demand for investment within the West. The thesis of depressed demand lying at the heart of the Western post-crisis malaise is now widely supported.

So why are we not moving to stimulate demand through other measures?

It is not for want of ideas and policy proposals. Financial technocrats have begun to countenance such a move. Adair Turner, former chief of the UK’s Financial Services Authority, has recently called for ‘monetary financing’: using central bank money creation to directly stimulate demand through enabling tax cuts or increased public expenditure to finance fiscal deficits without incurring new debt obligations.

An even more direct measure would be to credit the bank accounts of ordinary workers. Turner recommends targeting poorer citizens, as they have a higher propensity to consume rather than save. According to Turner, these policies provide a more direct and effective stimulus than the financial-market mediated and regressive distributional consequences of Quantitative Easing, which has differentially benefited wealthy asset holders through inflating asset prices while failing to lift long-term growth.

There is much to commend in Turner’s bold proposal. But such measures are unlikely to be undertaken without substantial political change. This is because at its heart, the question of how to escape the new stagflation involves a crucial political dimension: discipline.

Neoliberal policy principles have elevated a certain kind of discipline, ‘market discipline’, as the central credo of institutional restructuring and macro-economic policymaking. This has manifested itself in a fixation with fiscal rules, inflation targets, the retrenchment of welfare and rolling out of workfare and the identification of trade unions as the obstacles to the proper functioning of the market.

In practice, discipline has only ever been applied inconsistently, with the poorest and weakest most likely to be targeted while the powerful and systemically significant, as the bank bailouts demonstrated, are likely to be spared the full force of the market.

Monetary financing entails two significant relaxations of discipline that jar fundamentally with reining neoliberal ideology. Firstly, it would free up central banks to create money to finance expenditure and consumption directly, straining their mandate as bastions of the discipline of sound money and further undermining the imagined firewall between monetary and fiscal policy that maintains their formal institutional independence. Secondly, it would (if the policy of an electronic ‘helicopter drop’ direct to citizens bank accounts was enacted) lead to the substantial crediting of workers’ bank balances regardless of their market-based employment activity, thus cutting against the grain of market discipline and welfare retrenchment, as well as re-legitimating an expanded and potentially progressively redistributive state role in macroeconomic management.

Absent a significant political challenge to neoliberal dominance, then, the current stagflationary inertia, which leaves us mired in a fragile, high-debt, low-wage, low-investment and low-growth equilibrium, looks set to endure. Monetary loosening and correspondent asset price inflation are acceptable. But the loosening of market discipline upon ordinary workers and the turn to monetary financing of fiscal expenditure is not. Governments throughout the West have been clear about their commitment to fiscal austerity and increasing labour market flexibility.

Why does all of this matter in terms of the coming crisis? If the stagnation of Western political economies continues and, indeed, if the likely lurch back into recession occurs, the already fragile foundations of post-war democratic capitalism in the West will be put under even further strain. Continued deflation will increase the real burden of debt and stagnating growth will undermine the capacity for its repayment. Radical forms of anti-democratic and xenophobic populism will likely gain further traction. Here a central political lesson of the 1920s and 30s is key: societies can only absorb so much economic strain under the pressures of austerity and economic stagnation. If we are to avert the onset of the coming crisis, we will have to further loosen the political shackles of market discipline.

The Coming Crisis SPERI blog series – Next week: Scott Lavery on the Eurozone.