29 November 2011

John Murray: With a little help from your friends - the virtues of global economic coordination

The two most pressing challenges facing policy-makers today are:

• finding a solution to the European debt crisis; and
• putting the global economy on a path to strong, sustainable growth.

The first of these is in some sense logically prior to the second. However, providing a credible prospect of long-term growth is also necessary for achieving the first objective. Fiscal and banking problems are not going to be solved by deleveraging alone. It will also be necessary to expand the size of the global pie in a more evenly-distributed manner if long-run stability is to be achieved.

Major advanced economies with deficient demand cannot consolidate their fiscal positions and boost household savings without support from the external side in the form of increased foreign demand. Meanwhile, EMEs, seeing their growth decelerate because of sagging demand in advanced countries, are reluctant to abandon a strategy that has served them so well in the past, and have refused to let their exchange rates adjust in a material way.

Sterilised intervention continued at an accelerating pace over most of the past four years, and new “macro-prudential stabilisation tools” (i.e. capital controls) have been introduced to buttress their defences further. Advanced countries, receiving limited assistance from some of their most important EME trading partners, have been forced either to use what little fiscal space remains to stimulate their economies, or to resort increasingly to unconventional monetary policy remedies, such as the Fed’s quantitative easing. The latter, in turn, tend to push capital flows toward EMEs in ever-larger amounts, exacerbating EME concerns about reforms being proposed by any of the G20 countries. While it is difficult to garner the sort of political support necessary to drive significant change in the midst of a crisis, the reverse is also true. The momentum for reform seems to disappear once things appear to be getting better. Countries must break out of this paralysing pattern and, instead, seize the opportunity to do the right thing now.

Fiscal consolidation is proceeding more rapidly, in some cases, than short-term macro-economic conditions might warrant. However, countries are being forced to accelerate the pace of tightening by increasingly sceptical and impatient market “vigilantes”, lest they fall into the ranks of those already deemed too far gone to save. Ideally, countries would be able to outline a credible longer-term plan for fiscal sustainability, and receive in return increased room for manoeuvre (i.e. easing, or less tightening) in the short term. This Augustinian approach to fiscal probity is clearly difficult, if not impossible, to effect in practice. As a result, many countries are finding themselves with less room for manoeuvre than they expected.

Regrettably, it is movement on the exchange rate front and the correction of external imbalances that are proceeding at the most glacial pace. A way must be found to break this log-jam to everyone’s advantage. The Mutual Assessment Process (MAP) that the G20 has initiated and the use of indicative guidelines are expected to help push the process forward, but meaningful action, as opposed to agreement on the mechanics of the MAP, appears to be lacking.

Full speech

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