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World’s top economists worry about tools to fight economic downturn

World’s top economists worry about tools to fight economic downturn

October 13
05:28 2017

As the biggest names in economics gather in Washington this week they have reason for celebration.

The G20 countries are all growing for the first time since 2010, and International Monetary Fund predictions show global growth picking up from 3.2 per cent in 2016 to 3.6 per cent this year and 3.7 per cent next.

Nevertheless, many of the attendees at the annual IMF and World Bank meetings are finding ample cause for worry. The question is whether the world’s finance ministers and central bankers will have enough weapons left in the armoury to deal with the next economic downturn when it comes.

“It is not clear that if a recession came next year we would have the [necessary monetary policy] tools,” said Olivier Blanchard, the former IMF chief economist, speaking at an event with many leading economic figures at the Peterson Institute for International Economics on Thursday.

The dilemma is clear — in a future crisis, it may be difficult to use either of the traditional tools to revive growth: interest rate cuts and government policy on spending and tax cuts.

At present, growth is still too slow and inflation too meagre for official interest rates to be raised by much, which limits the room for recession-countering cuts in the future.

Public indebtedness as a share of gross domestic product in the advanced economies is also at its highest since IMF records began in 2001, which constricts the scope for fiscal policy to counter a downturn. 

The problem is acute in some of the biggest economies — including the US.

Despite Congressional Republicans’ appetite for lowering taxes, many lawmakers remain ideologically opposed to the use of tax and spending policy to stimulate the economy.

Although the US Federal Reserve is in the process of increasing interest rates, it expects the official rate to go no higher than 3 per cent, meaning it will have less rate-cutting firepower in a future downturn and will have to resort to less conventional tools to stimulate growth in the future. 

According to Ben Bernanke, the former Fed chair, policy rates could be at rock bottom levels for as much as a third of the time. “Monetary policymakers may have limited scope to address deep economic slowdowns through the traditional means of cutting short-term rates,” he said in a paper released on Thursday. 

Because of such limitations, the Fed is clearly prepared to use quantitative easing again, alongside pledges to keep rates low, although at least one candidate to take over as Fed chair — Kevin Warsh — has expressed scepticism about QE in the past. 

Lowering rates below zero — which has been used in Japan and the eurozone — is an enormously contentious area in the US that no policymaker would relish trying, even if it may be technically possible.

Some Fed economists have mooted the idea of raising the US’s inflation target from 2 per cent — which in theory would lead to higher rates and more rate-cutting firepower.

But Mr Bernanke suggests an alternative in which the central bank would commit when rates are near zero to make up for below-target inflation by shooting for a spell of above-target inflation, so implying rates are kept low for longer and contributing to a recovery. 

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Not all policymakers are convinced by this idea of a “temporary price-level target”.

Lael Brainard, a Fed governor, suggested Mr Bernanke’s idea had merits but also fretted that the public might start to doubt the central bank’s commitment to the 2 per cent inflation target, which under Mr Bernanke’s framework would continue to prevail in more normal times.

Mr Blanchard is pessimistic about central bankers’ ability to convince companies and households to spend money in a downturn because of expectations that inflation would rise soon.

“It’s very hard to change expectations at the time you need to change them,” he said. “It doesn’t work.” 

With interest rate cuts unlikely to be sufficiently effective in another downturn because they will not start high enough, Mr Blanchard and Lawrence Summers, the former treasury secretary, advocated much more effective and planned use of fiscal policy. 

In a joint presentation, they called for governments to put in place plans for aggressive fiscal stimulus in the event of a downturn.

With extremely low interest rates and the economy likely to grow faster than the interest rate, “you can issue debt and never repay it and the debt level will never explode” as a share of national income, Mr Blanchard said. 

In such a way, they hoped economic growth could be more sustainable than it has been in decades. “In what period has the economy grown in a healthy sustainable way and with a sustainable financial foundation?” Mr Summers asked. “It has been a long time.” 

They were challenged from the floor by Robert Rubin, US Treasury secretary in the 1990s, who famously generated an economic upswing after reining in US budget deficits and improving confidence. Mr Summers insisted conditions now were different. 

The time for a new consensus on how to respond to a recession is pressing, since the current upswing in the US has already been the longest since the second world war and, statistically, the chances of a downturn increase with the length of the previous recovery. 

But with the most respected brains in economic policymaking still discussing the outlines of the right framework rather the details, if the world economy slid in the years ahead, the main lever of policy would remain what it has been for the last decade: improvisation.

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