How to Avoid a Double-Dip Global Recession
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 competitiveness 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.
This article originally appeared at Project Syndicate.
All rights reserved, Roubini GlobalEconomics, LLC
16 Responses to “How to Avoid a Double-Dip Global Recession”
I am beginning to feel we are entering a double dip. People need to think in post 2008 & pre 2008.
Dear Prof. Roubini,I fully agree with your thoughts here, however I’m still disappointed that you’re taking seriously the effect of CDSs on sovereign debt. In my opinion, CDSs say no more about the economy, financial or real, than the runup in the price of oil to $140/barrel a couple of years ago said about the supply of oil.Prof. Krugman, in his arguments looks at the interest rates on Treasury debt to see what the market is “saying” about the US fiscal deficit, not CDSs(as far as I know).I wish someone would do some research on this. If they did, they would probably find out very quickly that the changes in CDS spreads are being manipulated in a speculative attack against sovereign debt, nothing more, nothing less.Once this is known, then it will be understood that their is no “information” in the changes in CDSs spreads, and policymakers can be free to ignore them.Better yet, since no one understands derivatives anyway, they should be banned entirely.
Dear Professor Roubini,For “their” read “there”.Sincerely,Anonymous CowardP.S. The G-20 austerity looks like it’s going to go through. Once the inevitable happens and the world enters a double-dip recession or even Second Great Depression as a result of this stark,raving mad fiscal austerity, what suggestions do you have in that situation?This is something that really needs to be thought about and NOW! The world will be entering deflation and depression very soon because of the austerity regimes being put in place as we write.Perhaps the next time, governments will nationalize the banks outright, force them through a bankruptcy procedure instead of bailing them out with more government money. That would be a start for new thinking on the upcoming financial collapse which will be caused by these fiscal austerity policies(have I said this before?).
Sorry Guest, there is really nothing that can be done. Those who think so are delusional.How do you see Greece, Portugal, Spain and others? You think that they should be able to continue their very generous social programs at the expense of whom?I would also liked to have retired at 55 with a fully supported pension and free health care. The numbers never worked out. The PIIGS were able to manipulate the system just like Lehman Bros and others did to benefit themselves at the expense of others.Your solution is to continue this?The US (in the name of future taxpayers) already bailed out European banks after the subprime debacle. Of which they were just as big of players as our banks. But we bailed them out.We committed to the European stabilization fund thru the IMF. The US has its own issues, including underfunded pensions and Medicare plus a few wars. Are you suggesting that the US continue to support Europe so that people in Europe can continue their social programs at the expense of US citizens?The US’s government debt ratio is already near 100% debt to GDP and I understand that doesn’t include promises made on our own social contracts. And if you haven’t noticed, taxes collected in aggregate are in a downward channel. This means less ability to pay for that which has already been borrowed.The deflationary spiral that I believe the world is already in, had nothing to do with austerity. It has to do with to much debt to be serviced thru income made from value added endeavors. Most of the OECD has been living way beyond its means supported by debt lent to them by the savers/producers.It would be insanity to believe that this could continue forever. When the productive parts of the world rely on the Wimpy’s (Popeye cartoon fame) not only for their buyers but also as a place to invest their profits, then there really was only one outcome. The Wimpy’s default on the loans and everybody looses.As Richard Russell said a few years back, the winners in this next cycle will be those who lose the least.No! doing the same things and expecting different results is not sanity. It is not logical. It is not practical. It is insanity. And just because the government is insane and promotes insanity, doesn’t mean you have to believe their BS.There are no good consequences from living beyond your means. In the end, all you have is a bunch of worn out stuff and debt.
The 4 State $2 Trillion Annual Fishing & Tourist Industry MeltdownHaven’t seen much discussion on the impact this will have on GDP. Further the $20 Billion BP Black Pig down payment on this disaster is a drop in the bucket given the size of the pending losses and the time duration of said losses for they may persist for as long as 40 years (another Exodus wilderness experience) as the Dead Zone continues to spread in the Gulf and families evacuate the area to seek other employment.Guess who will pick up the tab for a BP shortfall when they finally get around to filing for Chapter 11 bankruptcy protection.Look Out Below
Bravo eco!However, quest has a good point “Perhaps the next time, governments will nationalize the banks outright”, is something the Professor has outlined before. Of course our right wingers would scream socialism/communism.Something will be done, but what? If only Bernanke could be trusted. Humans have much to be desired… resulting in games and behavioral economics.Also, in case you missed Ferguson at a Petersonn Institute Event.Ferguson: Fiscal Crises and Imperial Collapses.http://www.blip.tv/file/3624411Ferguson: Q&A Sessionhttp://www.blip.tv/file/3624459
Taking the TBTF into receivership was a good idea but couldn’t happen as the TBTF have to much power in the government. The Treasury Sec and Chief Economic Advisor are both from the TBTFs. Corruption of ideas lead to this mess and until the purveyors of these corrupted ideas are ousted from power, nothing will change. And that won’t happen until the ideas are proven false, and I mean depression.It will not be easy to wrench power from those who believe they deserve.I really believe that the ideas that are running the financial industry are a perversion of Capitalism and not Capitalism. I believe in Capitalism but we no longer have it. What we have I call Corpocracy which is close to Fascism. Even the idea that we have a democracy is ludicrous as two privately held corporations decide which two candidates you get to vote for.I am very interested to see how America gets itself out of this mess. History I think suggests that it will not be peacefully. I am sad that greed and hubris was allowed to overshadow common purpose and the common good.
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