The G20 leaders meeting in Los Cabos confront a number of challenges. Most prominent among these is the state of the global economy, which remains dangerously unbalanced, and in which the balance of risks is clearly weighted on the downside. These risks emanate from several sources:
- The euro zone remains in crisis, with underlying institutional and governance weaknesses still to be adequately addressed. Growth in Europe has once again stalled and uncertainty surrounding the euro clouds the outlook. The result has been higher unemployment that, in some euro-zone members, is now at Great Depression levels.
- In contrast, the US economy has continued its steady — albeit tepid — recovery, with unemployment trending down slowly over time. Although there are grounds for cautious optimism, the medium-term fiscal situation is worrying, while in the short term, the threat of a potential fiscal shock, with the expiration of tax cuts and a repetition of the debt ceiling brinkmanship of a year ago, weighs on the outlook.
- New concerns have also emerged about the sustainability of growth in China, Brazil and India, and other dynamic emerging economies that have fuelled global recovery, but which have relied on an export-led growth strategy.
Success at Los Cabos can be measured in terms of credible, effective commitments made to mitigate these risks, including:
- Governance arrangements to facilitate risk-sharing among euro-zone members and to create a euro-zone-wide deposit protection system with clear rules for European Central Bank lender-of-last-resort facilities;
- In the United States, credible commitments to fiscal sustainability that are conditional on the state of the economy, as Larry Summers has proposed, which would anchor expectations regarding future fiscal probity, reducing uncertainty, while guarding against a near-term risk of an unwanted, damaging fiscal shock; and
- Clear commitments to inflation targets and concomitant exchange-rate flexibility in dynamic emerging economies that are currently conflicted by a desire to prevent excessive appreciations of their currencies and the need to contain inflationary pressures emanating from abroad — attempts to achieve both could guarantee success at neither, and impart a deflationary bias to the global economy.
At the same time, leaders will address a range of other issues that have figured prominently in previous summits. Especially noteworthy is international financial regulatory reform, including the implementation of new capital rules, strengthened cross-border resolution regimes, rules and regulation on trading, clearing and reporting of over-the-counter derivative contracts, and a framework for understanding and mitigating potential risks from the so-called “shadow banking system” which operates outside the regulated banking sector. In addition, the diminished growth prospects and heightened public debt burdens bequeathed by the crisis undermine efforts to address food security and sustainable development, and to undertake timely, effective action on climate change adaptation and mitigation. All of these issues will take time to resolve.
The immediate challenge is to promote "strong, sustainable and balanced growth" within the G20 through multilateral review of, and consultations on, members' policies. As articulated by G20 leaders at the Pittsburgh summit, this is the objective of the MAP.
Initially, efforts to cooperate were facilitated by a common threat: faced with a global financial collapse that threatened all, a common, coordinated response was possible. This response was supported by a clear consensus on the part of international institutions, academics and the think tank community, with respect to the appropriate use of extraordinary monetary and fiscal policies. As countries have emerged from the crisis at different speeds, however, the nature of the needed response has changed. The goal is no longer the same policy response at the same time, but policy responses calibrated to individual country's circumstances. Unfortunately, these differentiated policy requirements are both more difficult to agree on and more difficult to monitor.
Moreover, the extraordinary policies that G20 countries adopted to prevent a catastrophic collapse in output have created new challenges to effective cooperation:
- Central banks in key advanced economies have adopted exceptional measures, including quantitative easing to mitigate the effects of de-leveraging and support growth.
- Meanwhile, the public debt burdens of many advanced economies have increased dramatically, as governments allowed automatic stabilizers to operate, undertook proactive fiscal stimulus to protect output and employment, and as a result of efforts to attenuate the effects of bank failures.
As a consequence of these effects, capital flows have increased to the dynamic emerging economies that are growing rapidly and which offer the prospect of higher returns, while many advanced countries are pursuing fiscal austerity — some, in Europe, under the threat of a possible loss of access to the bond market. For countries that have relied on an export-led growth strategy based on strong consumption in advanced economies, this conjuncture is especially challenging.
The problem is that, for advanced economies undergoing the effects of de-leveraging and fiscal austerity, expansionary monetary policy that results in a depreciation of their currencies and facilitates a rebalancing of global demand is wholly appropriate. But dynamic emerging economies, which are reluctant to absorb the appreciation of their exchange rates and fearful of fuelling asset price bubbles (particularly when some others have tied their currencies to the dollar), have resorted to "prudential regulation" to limit capital inflows and suppress the appreciation of their currencies.
In part, this response may reflect a desire to maintain the current account surpluses that have provided a cushion of foreign exchange reserves. From the perspective of individual countries, this process of self-insurance through reserve accumulation is a sensible, prudent strategy. Indeed, it can be argued that self-insurance has served the dynamic emerging economies well, given the limited impact of the crisis on their economies and the rapid recoveries they have enjoyed. From a global perspective, however, efforts to resist the exchange rate adjustments that are required to facilitate global rebalancing pose a risk of insufficient global aggregate demand. And this, in turn, implies that the real exchange rate adjustments required to facilitate the needed rebalancing must come from inflation in surplus countries and deflation in deficit countries.
Such adjustments would be inconsistent with the goal of strong, sustained and balanced growth. Structural reforms can help facilitate real exchange rate adjustments and reduce the potential costs associated with the adjustment process, but they take time to implement and take effect. In the meantime, the G20 MAP remains the best hope for securing the timely, orderly rebalancing of the global economy that is needed to avoid a disruptive scenario. That will take a shared analysis of the problem and a renewed commitment to cooperation to support the goal of an open, dynamic international trade and payments system.
The IMF can help reanimate this shared commitment and help support cooperative agreements, but only if it is viewed as legitimate, credible and effective by its members. In this respect, the crisis has served to underscore the need for governance reforms to allow the institutions of international cooperation to assist their members in dealing with the challenges they face, and ensure that the global economy remains a source of growth and development. Moreover, the Fund must articulate a clear, consistent message on the role of monetary and fiscal policies in key economies confronting the risk of prolonged economic stagnation. Absent effective global leadership from the Fund, individual national self-interest will prevail and effective international cooperation will remain merely an aspiration.