Since the great financial crisis that started in 2007, the focus has been on central banks. Finance ministries, on the other hand, seem to have retreated from the limelight after a burst of activity in the immediate aftermath. Even though the global economic situation remains unsatisfactory, if not outright worrisome, the ministries give the impression of being unconcerned. Public opinions and financial markets are fixated on the latest utterances of central bankers, apparently accepting the view that finance ministers are powerless. This is strange.
The current conventional wisdom among economists is that business cycles are best dealt with a combination of monetary and fiscal policies designed to rekindle demand. Central banks have responded, using first conventional tools and then adopting nonstandard policies as they pushed interest rates down to zero or below and allowing the sizes of their balance sheets to be multiplied several times over.
Part of the reason for these bold moves is that a financial crisis leaves a trail of huge private debts that undermine credit creation, as banks, firms and households proceed to deleverage. Yet, another reason is that central banks have felt compelled to make up for inactive fiscal policies.
Fiscal policies are necessary and possible
It may be that the conventional wisdom is outdated. After all, few economists foresaw the crisis and, when it started, few expected it to spread and deepen as it did. Several years later, however, while much has been learned about overlooked details of financial markets, the conventional wisdom remains. In a world suffering from insufficient demand, the result of excess saving, monetary and fiscal policies have a crucial role to play to restore growth.
The current debates concern the speed of sustainable potential growth, not the need for policies to close the gap between current and potential growth.
Many financial ministers argue that public indebtedness has reached unsustainable levels, in effect making it impossible for them to adopt expansionary policies. There is no doubt that, in many countries, the public sector needs to deleverage as well. When and how this may be done, however, requires more subtle reasoning than the outright rejection of fiscal policy. To start with, timing is of the essence. The time to rein back public indebtedness is when growth has returned, not when it remains tentative.
In addition, most developed country debts enjoy high ratings and, indeed, governments can borrow at rock bottom interest rates. At these rates, even moderately productive public investment is financially justified and will pay for itself. Furthermore, in the US, most European countries, the UK and Japan, central banks have absorbed vast quantities of public debts. In effect, these debts have ceased to exist since the cost of servicing them is nil: ministries pay interest to their central banks, which then pass their profits back to the governments.
This will not last forever, of course. Eventually, the central banks will sell back some of the public debts that they currently own. This will happen when growth is firmly back, and this is when public debt reduction will become imperative. Once again, this is not the time for public deleveraging.
So what is explaining inaction by finance ministries? An intriguing possibility is a lack of analytical ability. The contrast with central banks is startling. In nearly all developed countries, as well as in a growing number of emerging market countries, central banks have hired armies of highly competent economists. They produce top-class analyses, often pushing the limits of knowledge. Central bank policymakers are routinely exposed to these analyses, and many of them are highly competent.
Lots of expertise here, lack of expertise there
In addition, since the start of the crisis, central bankers and their staff have been in close touch with each other, eagerly learning from various experiments and constantly redefining best practice. This is probably the reason why they have innovated so much during the crisis, expanding their range of activities to financial marker regulation and supervision and the to the new, largely untested, macroprudential policies. Today’s central banks have as good internal expertise as is possible. The same cannot be said of financial ministries. While many of them have also moved some way to upgrade the quality of their staffs, they generally cannot compare to central banks. No new ideas have emerged from financial ministries, except maybe in the narrow area of debt management.
In addition, few ministers have any competence at all and they not always rely on qualified advisors. Occasionally, highly competent people are appointed as Finance Ministers. Some of them, for example in Italy and Sweden, have made a difference. Others, for example in Brazil or Ukraine, do not last for long.
More generally, most finance ministers are full-fledged politicians. This is a normal implication of democracy, but it has important repercussions. Their decisions are not just driven by economic considerations, they are shaped by the on-going political battle and by personal ambitions. A key question is whether they are even aware of the economic impact of their actions. There may be good political reasons for making economically wrong decisions, but this must be the outcome of a careful balancing of the relevant considerations. This is why the quality of the staff matters a lot.
Finance Ministers must have constant access and exposure to the best possible analysis. Judging from their actions in the wake of the crisis, and how they justify themselves, that does not always seem to be the case.
Technocracy vs. democracy
The fundamental issue is the role of technocracy in a democracy. Politicians are subject to the desires of the people while technocrats are an elite that should not impose their will. On the other side, politicians are subject to pressure from interest groups while technocrats normally provide uninterested competent advice.
Central banks are purely technocratic institutions that have performed rather well but, almost everywhere, they are now the objects of popular criticism. They probably should engage more openly the civil society. Finance ministries would do better if they were to build up the quality of their technocratic staffs, and listen to them.