“A dangerous new phase.” Thus the International Monetary Fund all too accurately sums up the global economy before the fund’s annual meetings this week.
Rising government credit risks, including Tuesday’s Italy downgrade, shaky asset markets, weakening growth: the makers of the horror movie of 2008 are clearly contemplating a sequel – “Lehman Brothers II: This Time It’s Sovereign”.
As the old saw goes, IMF stands for “It’s Mostly Fiscal” and given the lack of room to move on monetary policy in advanced economies, it is taxing and spending where most of the policy argument is focused.
You hear two polarised arguments about fiscal policy in a debt crisis: one, austerity never works; two, you don’t get out of debt by taking on more debt. Neither is necessarily true. But the problem right now is that the first holds in Greece, where policy is based on ignoring it, and the second fails to hold in Germany, the US and UK, where policy is based on accepting it.
The first ignores the successful use of fiscal tightening to escape debt crises in, for example, Brazil and Turkey in the early 2000s – the IMF’s last big rescue programmes before the long capital markets boom rendered it largely idle – as well as the oft-cited examples of simultaneous austerity and expansion of Canada and Sweden in the 1990s. But they, particularly Brazil, had the benefits of a rapidly recovering global economy to export into, and Canada and Sweden also had the ability to depreciate their currencies. Greece has neither. It cannot escape its predicament using fiscal policy. It needs a debt restructuring.
The second myth involves a wilful or ignorant confusion of short-run stimulus and long-run solvency. The irony is that, assuming growth in their economies will materialise despite short-run fiscal tightening, the US, at least the Congress, the UK and Germany are jeopardising the attempts of others to do the same. What those three countries think will reassure the markets about solvency will in fact scare them about growth.
Meanwhile, the source of much of this tension – the eurozone’s painfully slow and disunited approach to resolving the Greek crisis– continues. Its ministers still seem to think the financial markets will hang around for them to make up their minds without marking down asset prices and losing confidence such that the situation will have changed by the time they do.
Stories used to be told of the more utopian factions on the Republican side in the Spanish civil war, which reportedly used to convene meetings in the trenches to debate their next move. By the time speeches had been made and the vote taken, of course, the situation had often changed and they would find themselves charging straight into a wall of Nationalist machinegun fire but at least they had all had a say.
As for emerging markets, many, if not most, have conducted their short-term macroeconomic management with a competence from which western Europe and North America could usefully learn. Having carved out for themselves an unprecedented degree of counter-cyclical freedom by building up foreign exchange reserve buffers and fiscal surpluses, they were able to offset the 2009 recession.
But as World Bank president Robert Zoellick pointed out this week, they have much less fiscal space than in 2008 to counter a new downdraught. He noted that the fiscal positions of developing countries as a whole have deteriorated by 2 per cent of gross domestic product since 2007 and 40 per cent have government deficits of more than 4 per cent of GDP.
Couple that with the fact that, particularly in China, the structural change to a consumption, rather than export and investment-driven, economy has a long way to go and it is clear why economic weakness in the advanced world is filtering through to the developing one. As for quixotic talk of the Bric economies saving the eurozone with a bond-buying mission, it indicates that one thing the emerging markets have usefully learnt from their rich counterparts is the art of pre-summit media spin.
Absent a big change of heart on fiscal policy, or debt restructuring, there is not much most people will be able to do at these meetings except sit around and watch how the Greek situation unfolds. A dangerous phase, indeed – and the policy response is the most alarming part of it.
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