The central banks in the world’s two largest economies, Europe and the United States, took extraordinary actions this past week. They each promised an unlimited amount of money to help restore the economy.
By opening their money spigots indefinitely – essentially printing more dollars and euros – the banks are attacking one big problem: uncertainty. Too many investors and consumers still see too many unknowns to be confident about the future.
China, the third largest economy, has also turned on its money spigot. It promised $157 billion in new government spending to deal with an unusual slowdown in the world’s fastest-growing economy.
The Federal Reserve chief, Ben Bernanke, happens to be one of the leading scholars on economic uncertainty. In a 1983 paper, he showed how small-business owners will delay hiring and spending if government policies on taxes and regulation are too fickle over time.
Now as Fed chief he’s promising to spend $40 billion a month to buy up bonds in order to push easy money into lending markets, especially housing. This latest round of “quantitative easing” (or “QE3”) includes another extraordinary move for the Fed. Its buying spree will end only when the job market is healthy, Mr. Bernanke says. The European Central Bank (ECB), meanwhile, promises unlimited bond-buying to stem a lack of confidence in the eurozone.
The two central banks have become islands of certainty, forced to take unprecedented steps because other parts of government are failing. In Europe, the economies of Greece, Spain, and Italy remain unstable. In the US, the sharp ideological divisions of the 2012 election have left investors uncertain about future taxes and regulations.
Also unknown is how Congress will deal with the looming crisis of the “fiscal cliff” at year end, when nearly $500 billion in government spending might be cut. Consumer pessimism about the direction of the American economy went up last month, according to one survey.
What might help? By raising the certainty aboutUS policy to the level seen in 2006, or before the 2008-09 Great Recession, 2.5 million jobs would be created over 18 months, according to a 2011 paper from Stanford University.
That’s better than printing more money. Economies are restored when people trust each other more to do new types of business and when innovators come up with ideas that drive market demand (e.g., Apple’s iPhone 5). Governments must become honest about their financial situation – notably Greece. Politicians must seek consensus on economic policy – notably in the US. These things are the real liquidity of an economy.
Uncertainty is different from risk. The latter can usually be calculated by probabilities, with investments and spending doled out based on “risk levels.”
Uncertainty, however, involves immeasurable doubts, which can only be lifted when a society acts with greater harmony about its long-term future. The Fed and the ECB are hardly the institutions for restoring certainty to either the US or Europe. Other spigots need to be turned on.