The US has the opportunity – and perhaps the responsibility – to immediately retake a leadership role in global economic policy thinking, with the pressing priority of preventing the world’s recession from becoming something more serious. But what should be Mr Obama’s priorities in this regard, for example in the run-up to the G20 summit in early April – which, given the timetable for these things, will have an unofficial dry run of sorts at the Davos meetings next week?
The obvious message could be: a large US fiscal stimulus is coming, but the rest of the world needs to do more. In this option, Mr Obama could devote considerable effort to encouraging others to expand their government spending and/or cut taxes.
While worldwide cooperation of this form may have been a constructive thought last year at Davos, when the idea was first broached publicly by the IMF, a joint global fiscal stimulus is a glorious idea whose time has for now passed.
Much of Europe is facing impending fiscal pressures that mount by the day. The issue there is not fiscal stimulus but “fiscal capacity,” meaning the ability of governments to take banks’ (bad) assets onto the public balance sheet, and the danger is that not all European governments will feel able to even let their “automatic stabilizers” work fully (i.e., government spending goes up and tax revenue goes down in recession, without any discretionary change in fiscal policy.) There is currently hot debate on and around this issue at the European Commission.
Most emerging markets are similarly facing the prospect of difficulties in rolling over their sovereign debt – at least that part which is not placed directly with the domestic banking system. And the global social safety net that wants to give them some general reassurance and specific fiscal encouragement in this situation – the IMF – looks sorely frayed. Governments in middle income countries sensibly feel it is wiser to keep their fiscal powder dry. If you think they are overly worried, look at the latest data from Singapore today – 16.9% decline in GDP (a subscription link, but the summary data are in the free part) at an annualized rate in the 4th quarter of 2008 compared with the 3rd quarter; think of Singapore as a bellweather for international trade in goods and services at this time.
The exception of course is China, where there is long-standing scope for a stimulus. But the Chinese economy is only about 6% of world GDP and their effective additional stimulus per year is likely to be around 3% of GDP. 3% of 6% is essentially the rounding error in measuring the world’s economy, and you are unlikely to notice the effects of China’s stimulus globally – although it might just keep oil prices higher than they would be otherwise.
So what should Mr Obama emphasize? Given the latest economic and financial developments, three potential priorities stand out:
First, a world system-wide plan for recapitalizing banks and removing any toxic assets. This has to be implemented country-by-country and of course plans should vary according to circumstances, but the cross-border nature of banking calls out for a more coordinated approach. The US has always been a taste-setter in terms of what constitutes responsible economic policy, and Mr Obama should help persuade other leaders to adopt plans that broadly mirror his. And if they don’t follow suit, their domestic financial situations may well become more complicated.
Second, in the global bank clean up, some countries will find themselves short of cash, particularly foreign currency. Rather than risking more Iceland-type situations, the US should help arrange financial assistance where appropriate. This could be through the IMF but if there are historical objections (e.g., from Asia), alternatives can be arranged. The use of regional arrangements – including in Asia – should be encouraged, rather than discouraged; this would be a major departure for US policy.
Third, the world needs to avoid deflation. Moving the US to an explicit inflation target would help, particularly if the announcement is strongly supported (and explained) by the White House at the same time as there is dramatic further monetary easing among leading central banks. The point would be to demonstrate that the US can and will keep its inflation rate above zero without depreciating the dollar – and thus without exacerbating the difficulties of our trading partners. Remember that if countries do not want to cooperate with this approach, they risk appreciation of their currencies – this fear should concentrate minds in the eurozone.
This constitutes a major agenda with many difficult tasks. President Obama not only can do it, but he should. The alternative is a much deeper global recession with greater risks of further sovereign collapse – and many more American job losses.