The 2007-8 financial crash continues to overshadow the world economy. The big economic news last week was the decision of the US central bank, the Federal Reserve Board (Fed), not to increase interest rates.
This was a highly significant non-event. To understand why we have to go back to how the leading capitalist states got out of the Great Recession set off by the crash.
Basically, they ignored neoliberal dogma and opened the spending tap. This meant extra government borrowing.
But a slick political operation driven by the corporate media and surviving banks soon redefined this as a “sovereign debt crisis”.
The result was austerity, which was aimed at cutting public spending. But economies were still far too weak to manage without state support. The strain was taken by the central banks, which in the neoliberal era regained control over creating money and setting interest rates.
The resulting “monetary activism” took the form especially of quantitative easing (QE). Central banks bought government and corporate bonds from privately owned banks, effectively pumping money into the financial system. The idea was the banks would use this money to lend to firms seeking to invest.
When this didn’t happen, other measures were tried—for example, the introduction of negative interest rates, under which banks were charged for sitting on money.
But the plan was always that sooner or later monetary policy would be “normalised”. In other words, interest rates would be raised from the ultra-low levels they were cut to at the height of the crash, and QE would end. Behind this were two ideas.
First, there was the assumption that the crash and the Great Recession were just a blip in the expansion of a basically healthy capitalist system.
Once their effects had been overcome, there could be a return to neoliberal “normality”.
Secondly, there is a key orthodox economic dogma, the quantity theory of money. This asserts that if you increase the amount of money in the economy too fast, this will lead to higher inflation. Many neoliberal economists warned that QE would lead eventually to hyper-inflation.
But the path to “normality” has proved very rocky, as successive Fed chairs have discovered.
In 2013 Ben Bernanke, then chair of the Fed hinted that it would start tapering new money creation. The financial markets went wild, in the so-called “taper tantrum”.
Bernanke retreated fast. His successor Janet Yellen began to reduce QE and increase interest rates, but in 2016 she was forced to put this on hold when the Chinese economy ran into serious difficulty.
A year ago, Donald Trump replaced Yellen with Jay Powell. He was infuriated when Powell resumed Yellen’s policy of gradually raising interest rates.
The Fed also is not replacing the bonds it holds when they mature, which means it has stopped pumping new money into the banking system.
Trump was scared that the Fed would kill off the burst of growth the US economy has enjoyed since his election. But the orthodox economists at the Fed were worrying that falling unemployment would lead to higher inflation as workers felt confident enough to press for wage increases.
In fact, inflation is another highly significant non-event. Central banks have found it hard to get prices rising at their inflation target rate, usually 2 percent.
One reason for this is that the unemployment figures look better than they actually are because so many people have just given up looking for jobs.
But the main reason Powell gave for putting further increases in interest rates on hold is “cross-currents” in the world economy.
These are the impact of the developing trade war between the US and China, economic slowdown in the eurozone and China, and the disruption a hard Brexit may cause.
But the fundamental truth is that global capitalism, still deeply wedded to free-market ideology, can’t do without the crutch of the state. This marks what the left-liberal economist James Galbraith has called “the end of normal”.