The European elite is playing a dangerous game
By Scott Sumner
The Financial Times describes the global rise of populism:
In an age of rising populism, the Mexican president, though, is not alone in his suspicion of policymakers. US President Donald Trump prefers to follow his gut, Indian prime minister Narendra Modi has ridiculed western-educated economists and piled pressure on the reserve bank, while UK cabinet minister Michael Gove stated bluntly that people “have had enough” of experts.
The new Italian government might be the best example of this phenomenon, as the ruling Five Star Party has no real expertise in governing. Wolfgang Münchau argues that “Europe is in More Trouble Than You Think” and cites Italy as a possible trigger for the next crisis. He sees slow economic growth as being the underlying problem.
I’ve previously argued that bad monetary policies can lead to a distrust of free markets, which opens the door to extremist parties on both the left and the right. Argentina during the late 1990s and early 2000s is a classic example. But there’s another problem with weak aggregate demand, which is easily overlooked.
For the most part, populism is self-limiting. Most populist economic policies are destructive and voters quickly tire of the resulting economic stagnation. There is one exception; populist stimulus policies are actually constructive for a country that is suffering from deficient nominal spending.
It is well known that the Great Depression led to a surge in votes for the Nazi Party. These dramatic election gains put Hitler in a strong enough position to seize power in early 1933. Less well known is that the destructive monetary policies of 1929-32 also made it relatively easy for Hitler to subsequently generate rapid economic growth, which gave him even more political power than he would have had in a stagnating economy. Even under a dictatorship, public opinion has some influence on the power of the government.
In the United States, FDR was quite popular during the mid-1930s, even though most of his economic polices were actually destructive. This is because one policy in particular, dollar depreciation, was so constructive that the economy grew fast despite being held back by other policies such as the NIRA and the AAA. Something similar happened with a left wing government in Argentina after 2002. Obviously, the German case was very different from the democratic left wing governments of the US and Argentina. But all three had one similarity, unearned popularity that resulted from the incompetence of the previous government.
Suppose that over the next few years, populists sweep to power in EU elections as well as in numerous national elections. In that case, there will almost certainly be a change in the ECB mandate toward a more pro-growth policy. And that new ECB policy will likely be successful in the short run. Growth will pick up measurably. In the voters minds this will tend to confirm that the technocrats that had previously run the EU were wrong and that the populists are right about economic policy. The unearned popularity of the populists will give them the political capital to enact other aspects of their agenda.
The European elite is playing a very dangerous game. By insisting that the ECB stick with its current dysfunctional (contractionary) monetary policy, which leads to extremely slow NGDP growth, they are opening the door to political forces that could end up eventually sweeping them aside. If this happens it would not be just the bad ECB that is transformed. Europe may also end up losing many of its good institutions and practices.
PS. Italy already spends roughly 50% of GDP, and has a national debt that is widely regarded as excessive. Now the new Italian government is toying with the idea off selling off its gold reserves to pay for additional spending. What could go wrong?