It is time for the G20 to take seriously its mandate to agree on steps to stabilize the global economy and launch it on a more sustainable pattern of growth. Instead, the G20 is behaving like a debating society, with the cooperative approach that it fostered at the outset of the crisis devolving into an array of often-heedless unilateral actions by its members.
Yet there are several significant risks to global economic stability and prosperity that must be addressed urgently. Ireland has thrown Europe into its second sovereign-debt crisis this year and capital markets have become schizophrenic, with investment rushing back and forth across the Atlantic in response to contagion risk in Europe and quantitative easing in the US.
Meanwhile, capital is flooding into the higher-interest-rate emerging markets, causing inflationary pressures, driving up asset prices and subjecting currencies to competitiveness-threatening appreciation — in short, distortions and policy headaches that require unconventional, defensive responses.
Growth and employment forecasts in the advanced countries have been reduced — a delayed recognition of the reality of an extended and difficult recovery and a new post-crisis “normal.”
With lower and more realistic growth forecasts, fiscal deficits in the short to medium-term are viewed as more dangerous.
In the US, a subset of policymakers believes that weakening growth and high unemployment require a policy response. With a cyclical mindset and fiscal space exhausted, a new round of quantitative easing (QE2) might be defended as a strategy for mitigating the tail risk of another downturn in asset markets (mainly housing) and households’ balance sheets — and with it the possibility of a deflationary dynamic.
Worryingly, QE2 appears to be viewed in the US as a growth strategy, which it isn’t, unless one believes that low interest rates will reverse the private-sector deleveraging process, raise consumption and lower savings — neither a likely nor a desirable scenario. It also assumes that addressing structural constraints on competitiveness can be deferred — perhaps permanently.
The view from outside the US is that QE2 is either a mistake with negative external effects or a policy with the clear, but unannounced intention of devaluing the US dollar — a move whose main negative competitive and growth effects would most likely be felt in Europe, not in China, India and Brazil.
Unilateral action in this and other dimensions has undercut the G20’s mission of identifying and implementing mutually -beneficial policies in a coordinated way. A minimal requirement for G20 progress is that policies in emerging and advanced countries that have significant external effects are discussed and, if possible, agreed upon in advance.
Apart from the need to deleverage for a few more years, the US economy faces longer-term problems with aggregate demand, employment and income distribution that cannot be solved through consumption and investment alone. The US needs to expand its share in external global demand, which requires public-sector investment, structural change and improved competitiveness in the tradable sector.
Meanwhile, Europe struggles to find a solution to its deficit and debt problems by treating them with short-term liquidity fixes whose purpose is to buy time for fiscal consolidation and, in the absence of the exchange-rate mechanism, some kind of deflationary process to restore external competitiveness.