In many walks of life (sports, music etc.) the urge to be better than others can produce beautiful results, which are enjoyed by many. In economics, private sector competition has proven to be essential for generating a sustained upward trend in living standards through advances in knowledge and technology. Nevertheless, too much of a good thing can be bad. If competition does not take place within some well-defined legal and moral framework it can lead to excesses which threaten to undermine the very activity itself. The absence of a sufficient degree of financial sector regulation in the run up to the crisis is a case in point. Hence, there is a task for governments and regulators to provide a solid framework which ensures that private sector competition continues to produce social gains.
It would seem a logical conclusion that the degree of competition to which policymakers themselves are exposed should at least be more limited than that seen in the private sector. Cooperation seems a rather more fruitful model, especially to the extent that there are large spill-overs between the actions of various policymakers. Yet, strangely, before 2008 the prevailing consensus on optimal macro policy said something very different. Every policymaker was left to fend for himself while taking the actions of others as given. In practice, this led to monetary dominance. Central bankers were seen as the prime guardians of macro stability and they had the power to undo any macro effects of fiscal policy if they so desired. Meanwhile, regulatory policies were ruled by the mantra “as little as possible” whereas, “as smart as possible” might have been better.
The good news is that the idea of policy cooperation has been revived by two important global policymakers. First of all, at least in theory, Abenomics holds that the combination of the monetary, fiscal and supply side arrows should be more forceful than the sum of its parts. What’s more, last month the ECB President surprised friend and foe with a speech that states essentially the same thing. Draghi admitted that Europe has a big demand deficiency problem which could well morph into more structural damage on the supply side of the economy. In fact, after six years in which growth has been completely absent on balance this process is probably well underway. The way to tackle this thorny issue is to embark on substantial monetary as well as fiscal easing while simultaneously accelerating the pace of structural reform.
The idea that policy should tackle both the demand and the supply side is very refreshing in a world where, until recently, pundits tended to focus their prescriptions only on one side of this equation while completely ignoring the other side. More importantly, there is every reason to believe that this cocktail could be very effective as there are various important feedback mechanisms between the demand and the supply sides. The essence of structural reform is to move resources towards more productive uses but to do that one needs sufficient demand to shake things up. Conversely, supply side reforms which raise future productivity growth and lower the costs of adjusting resources to changing circumstances provide an incentive for firms to invest and hire more today.
In Japan, it took nearly 20 years of stagnation for policymakers to finally come to the conclusion that a coordinated vigorous policy push provides the best hope of getting the economy on a firmer footing again. Draghi obviously took this lesson on board. Whether or not the economy, under his watch, can skip the deflation phase now depends on his ability to convince other key policymakers in the region of the virtues of coordination.