There’s a hoary old proverb in the financial markets that a crisis happens precisely when the institutional memory of the last crisis has faded: when all the key chairs are occupied by people who aren’t scared any more, the same mistakes get repeated.
On that basis, in the face of grim economic news around the world, we ought to be reasonably safe from another Lehman Brothers-type meltdown, or even a repeat of the eurozone crisis. But what might be a little bit more worrying is that there are surprisingly few people left who remember how the normal kind of recession happens.
If we look back in time, we’re currently in the (surprisingly weak and slow) recovery process from a financial market meltdown in 2008 caused by the global real estate bubble. That bubble was itself basically caused by the interest rate policy response to the early 2000s recession associated with the dotcom and telecom bubbles. And it’s certainly possible to argue that a contributor to that telecom debt bubble was the “global savings glut” brought about by the late 1990s Asian and Russian financial crises. There’s a strong sense in which the world never completed the 1994-5 business cycle, having been interrupted in doing so by successive “committees to save the world”.
We’ve been living a sort of Groundhog Day existence ever since, constantly waking up to news of a financial crisis and trying over and over again to lower interest rates in just the right way to fix it.
But financial meltdowns aren’t the usual way in which recessions happen, and emergency credit lines and taxpayer bailouts aren’t the usual way that they’re prevented or managed. What normally happens is that there’s a shock of some sort to business confidence – say, political uncertainty or trade restrictions, as we’re seeing at the moment – and companies react to this by cutting back investment plans. Lower investment means lower overall demand in the economy, which justifies the original lack of confidence and triggers another round of belt-tightening, which also turns into a self-fulfilling prophecy. Things only come to an end either when there’s nothing more to cut and capital expenditure can’t be delayed any more, or (more hopefully) when the government realises that it has to make up the shortfall with deficit spending.
An orthodox Keynesian recession of this sort, unaccompanied by a financial market crisis, is the normal kind – and one of the best understood problems in economic policy. But the last such “simple” recession in the English-speaking world was back in the 1980s: in order to have been working age and felt the fear, you’d need to be quite a bit older than most of today’s key policy advisors. The tendency to recruit important economic policymakers from either tenured academics or bankers, neither of whom experience the business cycle in the same way as the rest of the economy, means that direct, gut-level appreciation of how this kind of recession works is even more lacking. For people whose entire recession experience has been driven by finance, the idea that trade and tariffs might be drivers of GDP is an academic understanding. As those clickbait stories might say, “only 80s kids will remember” watching the evening news conclude with a roundup of the lost export orders and factory closures announced that day. Followed by Nationwide and Top of the Pops.
It’s going to be worryingly easy for our policymakers to keep looking at financial market stress indicators, repeating slogans about small government and fiscal prudence, and ignoring the world around them. There won’t be any dramatic collapse or moment to shock everyone into action as there was in 2008, and nor will there be any global event to make different governments work together.
After a surprisingly long run, we’re going to have to relearn old lessons, probably the hard way.
• Dan Davies is a former Bank of England economist and investment banking analyst