Global financial markets are experiencing their steepest declines since the 2008-09 crisis, causing uncertainty throughout the global economy. As the US and eurozone grapple with sovereign debt issues, there is
much debate as to the best course of action to stabilize the global economy and the role of multilateralism in this regard. To get a better sense of the issues at play, we talk to CIGI Senior Visiting Fellow Manmohan Agarwal, former senior economist at the International Monetary Fund and former World Bank strategist.
CIGI: Last week began with the announcement of the US debt deal before the markets descended into chaos. How would you describe the impact of the US debt deal on the current market turmoil?
Manmohan Agarwal: The US debt deal, in itself, is not a big deal. Apart from Denmark, no other country in the world, apparently, has a debt ceiling. And the Denmark debt ceiling is so large that it doesn’t really matter. So it is only the US that goes through this charade of raising the debt ceiling. Because, in a sense, when you pass a budget and there’s a deficit, you’re implicitly saying that you’re going to borrow that money. So to have the same government agency creating problems to raise the debt ceiling means your left hand doesn’t know what your right hand is doing. It doesn’t make any sense.
The problem was that the markets were worried about what would happen if the debt ceiling wasn’t raised. But that threat they did not take very seriously, because there was no great drop in the markets before the debt ceiling agreement.
CIGI: Whether it’s in the US or the EU, at what point does the debt of a nation-state become a problem?
Agarwal: What is important is not the debt-to-GDP ratio. What is important is the ability to service the debt, mainly pay the interest payments. If you can pay the interest payments, the bank will roll over the debt, the bondholder will roll over the bond. So concentrating on the debt-to-GDP ratio is concentrating on the wrong thing. And by the debt-service-to-GDP ratio, it’s under two percent. It really isn’t a problem.
That’s where the situation in the US is different from the situation in Italy or Greece. In Italy, the interest rate they’re paying is six percent and their debt is about 120 percent of GDP. The interest payments are eight percent of GDP — that’s a lot.
CIGI: From a global governance perspective, how do you assess the coordinated effort from 2008 to the present?
Agarwal: What is happening is that the G20 was supposed to coordinate economic policy to restore growth — well, to stop the recession and then to restore growth. What has happened is that once the fears of depression were stemmed by somewhat coordinated action, attention swung to cutting deficits in the developed world. And the International Monetary Fund came out and said it’s very important that governments cut deficits to restore confidence in the markets. So everybody’s busy cutting deficits. It’s an inappropriate thing to do in the middle of a recession, and it’s not going to solve the problem.
CIGI: How much of this current crisis do you attribute to possible missteps in the responses to the events of 2008?
Agarwal: I think that what they did in 2008-09 was the right thing at that time. The problem has been, one, the fundamental issue in Europe that it’s very difficult, if not impossible, to have a monetary union without some sort of fiscal union. They’ve been trying to get a monetary union without a fiscal union and the weaknesses are showing up. And in the US, what you have is a conflict between the role of fiscal policy to stabilize the economy and what the long-term role of the government in the economy should be. The first issue is being embroiled by the second issue. You can have a large government, you can have a small government, and you can still agree that when there’s a recession the budget should be in deficit. What is happening in the US is that these two basic purposes of the government are being confused. So the problem is not the response to 2008; it has to do with more structural questions, which are complicating the problem of managing the world economy at this stage.
CIGI: In that regard, as countries try to cut their deficits, is there a difference between cutting expenditures and raising taxes?
Agarwal: The deficit is expenditures minus revenue. So whether you cut expenditures or raise revenue, the effect on the deficit is the same. And the effect of both on the macroeconomy is about the same, because both will mean leaving people with less income to spend. What really has an impact is what role you want the government to have in the long run: What should be the size of the government? The Tea Party has brought this question to the fore in the US, and there needs to be a debate about this rather than the use of fiscal policy for short-term stabilization.
CIGI: The G7 finance ministers issued a statement saying they would take “all necessary measures” to ensure credit isn’t frozen in the financial system. But they also mentioned “continuing fiscal discipline efforts.” Going forward, what type of coordination is required to strike the right balance of austerity and liquidity in the global economy?
Agarwal: The G7 finance ministers said that they will take all necessary measures to ensure that credit isn’t frozen. But European nations can’t do that because the European Central Bank (ECB) is independent. None of the finance ministers in the European countries has any control over the ECB. Technically speaking, the president of the US does not have control over the Federal Reserve either. So people in the G7 countries might be influenced by the finance ministers’ statements, but the reality is it’s one of those completely vacuous statements. They can’t implement anything.
CIGI: The same would also apply then at the G20 level?
Agarwal: Absolutely. In fact, in the CIGI Commentary that I wrote last year, I said that people were criticizing the G20 for not reaching an agreement on appropriate measures. But it is inappropriate to expect the G20 to come up with these measures. In most of the governments — the democracies — presidents or prime ministers have to go back to parliament and get approval for whatever prescriptive fiscal policy they want to adopt. So they cannot commit themselves — they cannot say, "I will raise expenditures by two percent." Similarly, many of them are not in a position to commit their central banks.
So to expect the G20 to come up with specific policy recommendations is barking up the wrong tree.
What the G20 does is that Obama goes there and tells them, “This is what I plan to ask Congress to do. What are your issues with this?” And they will say “You shouldn’t try and convince Congress to do x, you should try to convince Congress to do y.” Then, his job is to come back and tell Congress, “This is what the world expects of us.” And that’s where all leaders have been very poor. They need to use the G20 to move the domestic debate toward what the G20 wants, but it’s a slow process.