Friday, July 16, 2010

How to Avoid a Double-Dip Global Recession

Roubini has come up with another lucid and cogent set of categorical policy measures that, in his view, will go far to stave off and, avert a global double-dip:

There is an ongoing debate among global policymakers about when and how fast to exit from the strong monetary and fiscal stimulus that prevented the Great Recession of 2008-2009 from turning into a new Great Depression. Germany and the European Central Bank are pushing aggressively for early fiscal austerity; the United States is worried about the risks of excessively early fiscal consolidation.

In fact, policymakers are damned if they do and damned if they don’t. If they take away the monetary and fiscal stimulus too soon – when private demand remains shaky – there is a risk of falling back into recession and deflation. While fiscal austerity may be necessary in countries with large deficits and debt, raising taxes and cutting government spending may make the recession and deflation worse.

On the other hand, if policymakers maintain the stimulus for too long, runaway fiscal deficits may lead to a sovereign debt crisis (markets are already punishing fiscally undisciplined countries with larger sovereign spreads). Or, if these deficits are monetized, high inflation may force up long-term interest rates and again choke off economic recovery.

The problem is compounded by the fact that, for the last decade, the US and other deficit countries – including the United Kingdom, Spain, Greece, Portugal, Ireland, Iceland, Dubai, and Australia – have been consumers of first and last resort, spending more than their income and running current-account deficits. Meanwhile, emerging Asian economies – particularly China – together with Japan, Germany, and a few other countries have been the producers of first and last resort, spending less than their income and running current-account surpluses.

Overspending countries are now retrenching, owing to the need to reduce their private and public spending, to import less, and to reduce their external deficits and deleverage. But if the deficit countries spend less while the surplus countries don’t compensate by savings less and spending more – especially on private and public consumption – then excess productive capacity will meet a lack of aggregate demand, leading to another slump in global economic growth.

So what should policymakers do? First, in countries where early fiscal austerity is necessary to prevent a fiscal crisis, monetary policy should be much easier – via lower policy rates and more quantitative easing – to compensate for the recessionary and deflationary effects of fiscal tightening. In general, near-zero policy rates should be maintained in most advanced economies to support the economic recovery.

Second, countries where bond-market vigilantes have not yet awakened – the US, the UK, and Japan – should maintain their fiscal stimulus while designing credible fiscal consolidation plans to be implemented later over the medium term.

Third, over-saving countries like China and emerging Asia, Germany, and Japan should implement policies that reduce their savings and current-account surpluses. Specifically, China and emerging Asia should implement reforms that reduce the need for precautionary savings and let their currencies appreciate; Germany should maintain its fiscal stimulus and extend it into 2011, rather than starting its ill-conceived fiscal austerity now; and Japan should pursue measures to reduce its current-account surplus and stimulate real incomes and consumption.

Fourth, countries with current-account surpluses should let their undervalued currencies appreciate, while the ECB should follow an easier monetary policy that accommodates a gradual further weakening of the euro to restore competiveness and growth in the eurozone.

Fifth, in countries where private-sector deleveraging is very rapid via a fall in private consumption and private investment, the fiscal stimulus should be maintained and extended, as long as financial markets do not perceive those deficits as unsustainable.

Sixth, while regulatory reform that increases the liquidity and capital ratios for financial institutions is necessary, those higher ratios should be phased in gradually to prevent a further worsening of the credit crunch.

Seventh, in countries where private and public debt levels are unsustainable – household debt in countries where the housing boom has gone bust and debts of governments, like Greece’s, that suffer from insolvency rather than just illiquidity – liabilities should be restructured and reduced to prevent a severe debt deflation and contraction of spending.

Finally, the International Monetary Fund, the European Union, and other multilateral institutions should provide generous lender-of-last-resort support in order to prevent a severe deflationary recession in countries that need private and public deleveraging.

In general, deleveraging by households, governments, and financial institutions should be gradual – and supported by currency weakening – if we are to avoid a double-dip recession and a worsening of deflation. Countries that can still afford fiscal stimulus and need to reduce their savings and increase spending should contribute to the global current-account adjustment – via currency adjustments and expenditure increases – in order to prevent a global shortage of aggregate demand.

Failure to implement such coordinated policy measures – to sustain global aggregate demand at a time when deflationary trends are still severe in advanced economies – could lead to a very dangerous and damaging double-dip recession in advanced economies. Such an outcome would cause another bout of severe systemic risk in global financial markets, trigger a series of contagious sovereign defaults, and severely damage the growth prospects of emerging-market economies that have so far experienced a more robust recovery than advanced countries.


hishamh said...

Very good remarks from RGE - but I'm wondering how realistic international cooperation and coordination will be.

walla said...


So now that the advanced economies are in trouble because they thought they could continue to just print money to satisfy their cravings for an easy and perpetually consuming lifestyle, they are trying to keep that lifestyle by asking the emerging countries to make their same mistake.

But the emerging countries are exactly where the advanced countries themselves were long ago, in those days of the miserly european traders and the austere puritan brothers. Thrifty because they don't have the luxury of a social net, hardworking because they find they can make honest living after years of hard perseverance sitting it out, and energetic because they can begin to build their own future and their nations and end decades of suffering. They also have something which the west doesn't have - the family unit in an extended social network where the self is denoted by responsibility to others. So if they spend more on themselves, they will break that principle. And if they spend more on others who depend on them, they will have to make more first.

What about advanced countries knuckling the emerging economies to strengthen their currencies? A precedent in history was set with the Plaza Accord. The result was a boom in quality of the exported products which then commandeered the entire top of the consumer pyramid, thereby achieving the opposite of what was intended. So would the advanced economies still want the emerging industries to follow the same track? Secondly, it was perhaps thought that by making imported goods more expensive just on account of the upgraded currency, the domestic importing market would prime its own production to replace and reduce imports. But doesn't that mean there shall have to be another accord which says in the event the advanced economy's currency weakens in the future, it shall on its own be strengthened to increase the cost of its exports and therefore reduce their price competitiveness, thereby killing its own industries? Thirdly, if i hold a lot of your bonds redeemable in your currency, making my currency stronger now than how it was when i had used it to buy your bonds denominated in your currency will mean that when the time comes to redeem in your currency, i will have less of my currency so exchanged to spend in my own market.

In all other words, one cannot say 'your problem is your problem and my problem shall be your problem'. One cannot have the cake and eat it. There is no free lunch. Money doesn't grow on trees, especially it being printed from them is the cause of all the problems in the first place. And certainly, double standards will deliver only double results.

Which comes back to Have we been behaving like an advanced economy in our frivolous consumptions? Yes. Have we been behaving like a real emerging country in our thrift, discipline and hard work? No.

So, will we have a double-dip local recession? It depends on whether you also think a few hundred million thrown away to try out a new fishing method which has not worked and the gear are all in a warehouse to be sold at a fraction of their hyperinflated prices is ok because it's still good r&d.

In the end, it depends on how we define what is good. But it also depends more on who is doing the defining and dishing out the money. Your money.

walla said...

But if the call is to emerging markets to reduce their current-account surplus by buying more goods and services from advanced economies, what exactly are they to buy when what they themselves make are cheaper and good enough for their own consumers?

The advanced economies supply fast-food, machine-tools and medicine. In emerging economies, fast-food is just weekend outing food; they can't be eating idaho potatoes everyday. And if they buy machine tools, it must be to make things to sell. But why should they buy expensive tools when they can make their own more cheaply and why should they buy more if the resultant surplus production is not to be exported to reduce the current-account surplus? And if they are to buy medicine, why should they when they have their own alternative herbal therapies which are more holistic in treating ailments what more with the high cost and elitist exclusion of western medical education which make it impossible for many smart students in emerging economies to afford it enough to understand the efficacy of such medicine in their own societies?

So the whole whachamacallit package hinges on the emerging economies spending more than they are currently doing by buying more from the troubled advanced economies and regardless - but what are they to buy? They can't buy garments and umbrellas from those economies because those garments and umbrellas are all made by them. They can't buy services because those services are only tested in the advanced economies, mostly with disputable results. And they don't need to buy consumer technologies including chunky automobiles and greening technologies because these are made by their own industries in their own backyards. But what about software, someone pips in? Well, why should poorer countries buy expensive software whose functions will be hardly used in full, and also, if they do buy them, will the extra profits made by the software companies be distributed to the other advanced industries which need to be revived so that the arrangement can be ended faster? And if it is suggested that the emerging economies buy into the companies of the advanced economies, there must be compelling business reasons to do so. After removing the window-dressed accounts, inflated market size projections and phantom customer lists, what will be the final valuations which will provide more compelling grounds than investing in home-grown businesses in bursty markets in own country?

Yet the whole principle has Smith's invisible hand. Work for self only so that market can cherry-pick and choose the most optimal solution out of many selves working for themselves. When the going was good, the advanced economies worked for themselves only. That's why they have been able to exact terribly low buying prices on the emerging countries until the workers of the overseas suppliers commit suicide from being underpaid and overworked, and then the advanced countries went on to add fuel to fire by yelling at them to show more human rights when they themselves have long jettisoned their humane rights in their chase for more profits at all costs, so long not theirs.

de minimis said...

Bro hishamh

That is truly the challenge. In spite of the numerous conferences finance and economic ministers and so on, including the ultra-glam world economic forum consensus is an elusive goal