A Plea for Macroeconomic Cooperation

It looks already as if 2016 will be a pivotal year for the world economy. RBS has advised traders to “sell everything aside from high-quality bonds” as turmoil has came back to stock markets. The actual Dow Jones and S&G indices have fallen by more than 6% since the start of the year, which is the worst ever, annual start. There is a similar tale in other major marketplaces, with the FTSE leading companies dropping some £72bn of value in the same period.

These declines have come on the back of a major shock to the Chinese stock market. China’utes stock exchange is very different from those of other major economies, because Chinese companies don’t rely on it to fund themselves towards the same extent, using financial debt instead. All the same, the repetitive suspensions of trading because the Chinese circuit breakers came into procedure (as they do when share prices fall too sharply) spooked investors around the world.

On top of which, we are seeing commodity prices continuing to retreat. Oil costs have dropped towards $30 for each barrel and don’t appear likely to increase soon, with Iranian and Saudi oil production continuing to sustain supply. There has been many emerging economies determined by petroleum revenues suffering (South america, Russia), and there is speculation that many oil producers (and perhaps even Saudi Arabic) are abandoning their currencies’ link with the US dollar.

Demand and supply

There are two different perspectives on the reason why the world economy is still struggling eight years after the economic crisis. The first suggests it is struggling with too little global demand following the financial crisis. The argument is that in the world economy as a whole, customer spending and corporate investment have been held back by a insufficient confidence. This has been aggravated by austerity in many of the sophisticated economies in the western hemisphere following the financial crisis caused government debt to spiral.

Confidence conundrum  kmlmtz66 (right)

According for this view of the world, monetary coverage can’t encourage demand to get when interest rates are already from or close to 0%. A recuperation will not happen unless government authorities restore confidence through matched fiscal action – ramping upward public spending worldwide. This really is Keynesian demand-side view of the world, echoing Keynes’ view the post-war global economy required management in terms of overall levels of need.

An alternative view is that the world’utes economic stagnation been caused by an expansion of global savings, partially driven by the emergence associated with major economies such as China and India. Because business demand for investment finance has been weak, these excess savings have instead eliminated into things like government ties, leading to low real rates of interest.

In this world-view, emerging from the crisis does not require more government investing, but an expansion in investment opportunities for the extra savings, driven by innovation. It also requires a degree of policy co-ordination between countries to progressively raise central-bank interest rates towards “normal” amounts. Otherwise, the imbalances in savings between East and West are likely to continue, raising the risk of recreating the pockets in asset prices such as property, and excessive consumer spending in the industrialised countries.

Imperfect reality

As 2016 evolves, we should get some insight into which of these two world-views is correct as we begin to see if consumer and investment spending can recover without the need for additional federal government spending. In my view, the demand-side debate has greater merits, however there are three qualifications. Very first, to sustain consumer demand in any recovery, wage levels have to keep pace along with inflation. If this doesn’t happen, it will continue to drive inequality as well as hold back consumer spending.

Second, you have the complication that post-crisis debt amounts are still high in many nations. Household debt is still higher relative to GDP in the UK, The country, Portugal, Ireland, Canada and the US (amounting to between 80% and 110% of the size of the economy). Moreover, gross government financial debt as a proportion of the economy exceeds 100% in the US, Ireland, Italia, Greece, Belgium, Portugal and Japan.

Can the debt be totally reset?  pognici

Critics of the pure Keynesian position argue that unless these debt levels come down, it is difficult to see beyond a slow recovery. In the past, wars and inflation were because opportunities to restructure or inflate away debt. Our independent central banks make it difficult to use inflation as a way of reducing debt levels because we have given them the task of keeping inflation low. This does not prevent a matched fiscal expansion amongst the G20 financial systems to kick-start the world economy, however it does mean that we have a reduced arsenal at our fingertips.

Third, the US was able to use its dominant position to set a clear direction for the world economy until recently, which made existence easier for governments as well as central banks around the world. Inside a multi-polar world where countries set their own fiscal and monetary policies, there is the greater potential for individual countries to make policy mistakes as they (mis)interpret what is happening externally.

It would be good if, in 2016, we began to see greater macroeconomic cooperation between the G20. In an ideal world, the G20 financial systems would seek to share out the effort of sustaining globe demand through targeted community investments designed to restore company and consumer confidence. We had this very briefly soon after the financial crisis. Since ’09, there have been no attempts to behave collectively on fiscal coverage. Those days seem unfortunately very distant now.

To avoid a 2016 crash, the major powers need to pull in the same path is republished with permission in the Conversation