MARTIN WOLF is an influential commentator. His weekly column in the Financial Times is required reading for the international financial elite. Paul Krugman of the New York Times may be the darling of the left and the Wall Street Journal editorial page the bible of many on the right, but inside finance ministries few are cited as often as Mr Wolf. He likes to admonish policymakers. As a centrist who favours free trade and free markets, though, he does so from within the mainstream.
That makes his latest book striking. “The Shifts and the Shocks” is a fierce indictment of the global economy and a call for radical reform. Mr Wolf is reasonably impressed by the immediate response to the 2008 crash, when bold action from central banks, in particular, stopped a descent into depression. But he is scathing about virtually everything those in charge have done (or not done) since.
Six years after the crisis, he argues, the world economy is stuck in low gear and set on an unsustainable course. Demand is weak; where spending has picked up, it is too often the result of a dangerous new build-up of private debt. Financial reforms have only preserved the essence of an inherently fragile system. The euro crisis remains unresolved. Emerging economies, resilient after 2008, now face slow growth and debt problems of their own.
Much of this mess is of policymakers’ own making. Mr Wolf’s book is particularly critical of the premature rush to fiscal austerity and the handling of the euro crisis. He puts forward a series of reforms far bolder than governments have contemplated so far. To make finance safer, Mr Wolf suggests replacing a fractional reserve banking system, which takes in deposits and lends most of them out in longer-term loans, with a system of “narrow banking”, where deposits must be backed by government bonds. To sustain demand without relying on dangerous asset bubbles, he proposes permanent “helicopter money”, where governments run deficits that are financed by the central bank. For a man of the mainstream, this is brave stuff.
Mr Wolf’s proposals stem from an exhaustive assessment of the origins and contours of the crisis, which make up the bulk of the book. Plenty has already been written on this; “The Shifts and the Shocks” contains little that has not been said elsewhere. Mr Wolf’s contribution is comprehensiveness and a piercing logic in piecing the disparate elements together. He weaves the macroeconomic and financial elements of the crisis, its origins and aftermath, into an all-encompassing analysis. Along the way he demolishes many of the popular explanations—such as that the mess was due to greedy bankers or to loose monetary policy—as too simplistic.
The result is convincing and depressing; there are no quick fixes. The origins of the crisis lie in the revolutionary changes in the structure of the global economy and finance in the 1990s and early 2000s (these are the “shifts” of the book’s title). The macroeconomic shift was the emergence of a “savings glut” as countries from China to Germany saved more than they invested, pushing down real interest rates. Both at a global level and within the euro area financial innovation and freer capital mobility transformed these excess savings into huge cross-border capital flows, sending asset prices and credit soaring and, in the process, creating an inherently fragile financial system. Unfettered finance transformed the savings glut into a credit bubble. And in both cases the bursting of that bubble worsened the savings glut, as households, companies and governments in Europe slashed their spending.
Mr Wolf argues that the post-crisis recovery has been feeble because too many policymakers failed to understand this dynamic. Rather than accepting that bigger fiscal deficits would be the natural counterweight to private thrift, politicians pushed for austerity. Far too little emphasis was put on restructuring unpayable debts. At the same time, the underlying causes of the savings glut have, if anything, become stronger as deeper factors such as rising inequality have kept overall spending weak. Larry Summers, a Harvard economist, has argued that the rich world faces “secular stagnation”. Mr Wolf also believes that weak demand is here to stay. So, too, is the fragility of finance. Despite “manic rule making” he argues that banks are still a powder keg, with insufficient capital, and are liable to wreak havoc when they blow up.
This grim assessment leads Mr Wolf towards radicalism, both in macroeconomic and financial reforms. His more moderate suggestions include requiring banks to hold vastly more capital and the creation of insurance schemes that allow emerging economies, the most plausible engines of demand, to import capital safely and sustainably. But moderate change may not be enough. Pushing his analysis to its logical conclusion, he argues that the only way to deal with today’s underlying problems—a fragile financial system and a secular weakness in demand—may be to move away from bank-based credit altogether and rely on permanent budget deficits financed by central banks. Forcing banks to match their deposits with safe government bonds would reduce the risks of bank crashes and encourage a healthier reliance on equity finance. Permanent money-financed deficits would, in turn, provide a safer way to sustain spending than private-asset booms and busts. If done responsibly, they need not cause inflation.
Mr Wolf’s book has flaws. It is dense and confusingly structured. The hallmarks of his newspaper columns—a tone of absolute certainty, a fondness for numbered lists and copious IMF statistics—become exhausting over hundreds of pages. Mr Wolf is good at analysing what has gone wrong, but he spends too little time explaining his reform proposals. He may be right that narrow banking is safer than today’s system, but the brief description he offers is unlikely to convince the sceptics. “The Shifts and the Shocks” is not the last word on the global economy. But it is an important contribution that anyone involved in economic policy ought to read.