The world is as one on not endangering recovery

Gordon Brown, for all his faults, is usually right when it comes to macroeconomics. With hindsight, it is clear that the G20 summit he hastily organised in London last April really did mark the turning point in the global financial crisis, as he said it would. So in their follow-up meeting in London over the weekend, the G20 finance ministers could look back with reasonable satisfaction on achieving three of the four main objectives they set last April.

First and foremost, they saved the world economy with unprecedented fiscal and monetary stimulus. Second, they saved the major banks with unprecedented government guarantees. Third, they saved the most vulnerable countries — such as Greece, Portugal, Spain, Hungary, Latvia and Ireland — with unprecedented international bailouts, financed by the European Central Bank (ECB) and the IMF. The fourth objective was to save the global financial system from another catastrophe, and the regulatory issues relating to this aim, especially bank remuneration policies and capital requirements, were the focus of media attention over the weekend. But before getting too cynical about relatively minor disagreements on such secondary issues as bonuses, it is worth seeing how much consensus has been reached on the far bigger issues of monetary and fiscal policy.

Every G20 government and central bank has fully participated in the conversion led by Barack Obama and Gordon Brown from monetarist fatalism to proactive, Keynesian-style demand management, in the face of soaring unemployment and collapsing economic activity. Still more important is that no serious policymaker in any major economy is thinking of reversing stimulus policies prematurely, before a self-sustaining global recovery is clearly established.

There was clear consensus at the meeting that budget deficits must not be cut back for at least another year, despite the growing clamour about rising government debt burdens. And that consensus included even the German Government, despite its public protests against crude Keynesianism and its derision at the Anglo-Saxon policy of curing debt with debt. Not only did Germany introduce subsidies for car buyers much earlier and on a bigger scale than any other big economy — in a clear case of support for a national industry that might set an interesting example for British policy towards the financial sector — but its Government has been much more aggressive in providing Keynesian fiscal stimulus than the British, French or Japanese. Germany’s stimulus packages this year have been worth 3.4 per cent of GDP, according to IMF calculations, roughly double the size of the 1.8 per cent of GDP spent by Britain.

Judging by actions rather than words, therefore, the German Government has been among the most active exponents of crude Keynesian budgetary expansion in its response to the crisis. As one senior official suggested, the strategy is to say they won’t do things and then do them. This way, it seems, the German people can be persuaded to spend more money without worrying about the build-up of public debt, which their politicians simply deny.

Even stronger than the new-found agreement on fiscal stimulus at the G20 meeting was the apparent unanimity among central bankers that there could be no question of raising interest rates for at least another year, and possibly a lot longer. That this agreement on maintaining ultra-expansionary monetary policy included even those central bankers with the most hawkish reputations was confirmed by Jean-Claude Trichet, the ECB’s President, in a newspaper article.

As Mr Trichet made clear, central banks that discuss or prepare exit strategies from the emergency conditions of universal near-zero rates are not planning to implement them in the foreseeable future. The banks’ purpose in publicly discussing these strategies is merely to reassure investors and politicians that they have the tools to reverse monetary easing when the conditions are right.

The existence of these plans for monetary tightening gives no indication about their timing. And that timing is likely to be later rather than sooner. The reason for saying this is another crucial agreement on macroeconomic policy reached among the G20 ministers.

As one key participant put it, monetary policy must be set with a view to fiscal policy and its effects on demand. Central banks will have to wait even longer than they otherwise might to withdraw monetary stimulus if governments start to feel confident enough in economic recovery to implement fiscal tightening through higher taxes and lower public spending. Assuming, therefore, that most governments do start tightening fiscal policy gradually from 2011 onwards, no major central bank is likely to raise interest rates by more than a tiny, symbolic amount until several years later.

Confirmation that central bankers all over the world are aware of this interdependence between monetary and fiscal consolidation was probably the most important conclusion to emerge from the G20 meeting over the weekend. It suggests an encouraging viewpoint that has not yet been grasped by many businesses, household borrowers and investors: the period of near-zero interest rates, which most people still believe to be a strictly temporary aberration, is likely to continue all over the world for many years ahead.

So much for the macroeconomic policy harmony. Now for the issue on which the G20 could not reach consensus. The rows on bankers’ bonuses reflected much more important disagreements over capital requirements, in which the British and Americans were actually tougher on the banks than the Germans and French, among them Christine Lagarde, the French Finance Minister. While nobody wants to tighten regulation of the banks now, for fear of aggravating the credit crunch, the US and British position is that higher capital requirements and disclosure standards must be agreed urgently, along with a clear timetable for implementation. The European position is that these issues should continue to be debated, potentially for many years, by committees and sub-committees of central bankers, accountants and other experts.

The political reason for this disagreement is straightforward: if capital standards were tightened in the next year or two, European banks would have to disclose large losses and raise huge amounts of capital. This would mean that their present private shareholders would find their ownership stakes significantly diluted, implying in turn that much of the additional capital would probably have to be provided by governments, at least for a while.

The good news is that most US, British and Japanese banks have already swallowed these bitter pills. They should be able to meet tougher capital requirements without much further dilution of existing shareholders, provided the world economy continues to recover. And the one thing we now know for certain is that G20 governments and central banks will do everything in their power to ensure that this economic recovery does not falter. (Anatole Kaletsky, The Times)


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