Each year on the margins of the IMF/World Bank Spring Meetings there is a choice of conferences and seminars hosted by international financial institutions, think tanks and other entities. This year is no different. CIGI co-sponsored an event along with a number of other think tanks at Brookings last week. The discussions were both informative and, from my perspective, somewhat disheartening.
There seemed to be a consensus that the prospects for the global economy, which the IMF chief economist described as "too slow for too long," are not terribly bright. Admittedly, the conjuncture in the United States is reasonably good, with employment up. Yet there is disquiet that a negative shock could have a very adverse effect if monetary policy is already "maxed out," notwithstanding Janet Yellen's (and her predecessor's) assurances that there is more the Fed can do. Needless to say, the situation elsewhere is considerably less encouraging. The Eurozone remains burdened by existential challenges that only increase over time. China's growth is falling, as the Solow-Swan model would predict. Fresh concerns have surfaced about Japan’s long-term fiscal sustainability. And Brazil's twin political-economic crises are impairing growth prospects for Latin America.
There is broad agreement about where the global economy should go, but less agreement on how to get there. I am reminded of the old anecdote of the American tourist in Dublin who asks for directions. "Well," he is told, "if I was going there, I wouldn't start from here."
The point is that initial conditions matter; unfortunately, we don't have a particularly favorable set of initial conditions. It is possible to foresee a situation in which a continuing failure to move the global economy to full employment results in a steady fraying of the social fabric, political dysfunction and growing debt burdens as relatively small "fixes" are deferred and the effects of demographics kick in. Fortunately, it is also possible to envision an alternate scenario in which policymakers seize the thistle and act with resolution.
What would such measures be? The answer, I think, is clear: infrastructure investment, which in many advanced economies has been ignored and is required in emerging markets to allow them to continue on their path towards development. Moreover, as I have previously argued, such investments would help return interest rates to more "normal" levels as well as rebalancing global demand and begin to unwind some of the crisis pathologies. But in current circumstances governments are reluctant to undertake stimulus, even if it raises the productive capacity of the economy. It will take policy coordination of a kind that has been out of fashion.
To be sure, there was a remarkable degree of cooperation in the wake of the Lehman Brothers failure, culminating in the G20 commitment to inject liquidity to prevent a global financial collapse, provide fiscal stimulus equal to 2 percent of GDP, and resist protectionism. These measures refuted Hegel and avoided the mistakes of the 1930s. But this remarkable response reflected the simple fact that the interests of all were perfectly aligned: It would not have been in anyone’s benefit to allow the global economy to collapse. Moreover, the G20’s timely and appropriate response did not prevent members making another mistake — that is to say, misdiagnosing how difficult it would be to return to full employment. As a result, fiscal stimulus was replaced too quickly by fiscal austerity, leaving monetary policy as the only instrument in play. That has led to our present malaise.
The argument for coordination – or, as some will insist cooperation – is both straightforward and robust. In the present circumstances governments would obviously prefer to be at full employment, but are fearful of the fiscal consequences of higher debt loads. They worry that the effects of unilateral fiscal stimulus will be dissipated by exchange rate appreciation, with others benefiting. If others stimulate, however, they will enjoy the spillover without increasing debt loads. Of course, all thinking along the same lines is a recipe for inaction. As a result, all are worse off than a scenario in which all stimulate. Effective coordination (cooperation) that results in a coordinated fiscal expansion would generate a Pareto improvement in which some (and, arguably, all) are better off and nobody is made worse off.
The thing is, this felicitous outcome requires agreement on the “model,” by which I mean a common understanding of the nature of the problem and the effects of policy choices. There is no such consensus. While some see a window of opportunity to raise growth (and reduce the debt burden by growing the denominator), others see only dangers in temporizing with more fiscal expansion. That is why infrastructure investment is so critical, as Amar Bhattacharya and his coauthors have argued, and why efforts to better engage the multilateral development banks to mobilize advanced country savings would be so beneficial.