Chris Giles of the FT reports that central bankers are worried that they are “flying blind”; he quotes Lorenzo Bibi-Smaghi, formerly of the ECB governing board, saying “We don’t fully understand what is happening in advanced economies.”
Um, guys, that’s because you don’t want to understand. Nothing about our current situation, except maybe the absence of outright deflation, is at all surprising or mysterious.
We had a huge financial crisis, and the combination of a housing bust (on both sides of the Atlantic) and an overhang of household debt (also on both sides) has acted as a drag on private demand. Monetary policy quickly found itself up against the zero lower bound, while fiscal policy, after providing some stimulus, soon turned strongly contractionary. Here’s real primary (non-interest) spending, from the IMF’s latest World Economic Outlook, with the blue lines representing the historical average in recessions and aftermath, the red lines representing current policies:
It was obvious both from history and from textbook economics that the turn toward austerity would greatly damage prospects for recovery; this isn’t hindsight. But many central bankers and other officials chose to ignore all that and place their faith in the confidence fairy instead. So now that it has all gone wrong, they throw up their hands and say that it’s a mystery — how could this happen?
No mystery, guys; you messed up.