Economic historians and others interested in the Great Depression still turn to the economic publications of the League of Nations as a basic source for understanding the economic catastrophe of the 1930s. While I don’t want to give anyone in Washington DC stage fright, the publications of today’s international organisations, such as the IMF’s World Economic Outlook which was published in full last week, will also serve as a first port of call for the historians of decades hence. So: how are they shaping up?
Extremely well, is my reaction after having finally given the April WEO the attention it deserves. This is essential reading for people seeking a global overview of the crisis, and advice as to how to get out of it.
The first thing to be said about this report is that the first two chapters, which summarize where we are today at both the global and the regional levels, are a masterpiece of synthesis. Getting the right mix of generalization and detail right is hard when writing global history, and the authors have pulled it off splendidly. A key theme throughout is the negative feedback loops which exist between financial sector stress and the real economy; and it is these links which are largely responsible for the severe downside risks to the already gloomy baseline forecast which are discussed in great detail (pp. 17-26). From an Irish perspective, we are already seeing the impact of financial sector stress on small businesses around the country, and it is predictable that a reverse chain of causation, from rising unemployment to difficulties with mortgage repayments, putting further stress on banks, will start to operate in the near future. (One hopes that the Government understands this, and that the exclusion from NAMA of residential mortgages does not imply excessive official optimism regarding this component of banks’ assets.)
Another contribution of these chapters is to show how the initial shock has been transmitted across the globe through trade and financial linkages, with the precise nature of the transmission mechanism varying across regions. The collapse of exports and industrial production in Asia is something that was entirely absent 80 years ago, but the combination of sudden stops of capital inflows, and falling prices for commodity exports, experienced in other regions is in many respects a familiar one to historians.
It is Chapter 3, however, which has the best chance of becoming a classic statement of our current situation that will be read and debated and fought about in years to come. The broad message is well known at this stage, so I can be brief. First, recessions originating in financial crises are deeper and last longer than other recessions. Second, global recessions are also deeper, and last longer, than other recessions. The obvious implication is that this recession, or depression, can be expected to be long and deep.
The policy implications are stark, and spelled out sufficiently clearly and often that readers can be left in no doubt about them. Because of the interactions between the real and financial sectors, we need aggressive policies both to clean up the financial system, and to support aggregate demand. Achieving the former requires inter alia “credible loss recognition of impaired assets”, adequate recapitalisation “taking into account both write-downs to date and a realistic assessment of prospects for further write-downs”, transparency, and possibly nationalisation. Achieving the latter requires both aggressive monetary policy and aggressive fiscal policy: “Governments have acted to provide substantial stimulus in 2009, but it is now apparent that the effort will need to be at least sustained, if not increased, in 2010,and countries with fiscal room should stand ready to introduce new stimulus measures as needed to support the recovery”. This emphasis on fiscal policy stems from the finding that when recessions are due to financial crises, this lowers the effectiveness of monetary policy, but increases the effectiveness of fiscal policy. (One can see ambitious grad students around the world reaching for their laptops at this stage.)
Because of the global nature of the crisis, countries can’t assume they will be able to export their way to recovery. Because of the move to higher savings rates in countries like the US, “it is unlikely that overleveraged economies will be able to bounce back quickly via strong growth in domestic private demand” either — hence the importance of government policy to support demand. As the report says, “governments can break the negative feedback between the real economy and financial conditions by acting as a ‘spender of last resort'”. Because of the trade and financial linkages between countries, policy coordination is essential: “fiscal stimulus should be provided by a broad range of countries with fiscal room to do so.”
The key in all of this is that the negative feedback loops between the real and financial sectors will continue to drive the world economy downwards if they are left unchecked — hence there is an overwhelming case for acting decisively, immediately, and globally.
Because this is the IMF, and not some bunch of wild-eyed radicals, the WEO worries in an appropriate manner about fiscal sustainability going forward, especially in the light of pensions problems coming down the line. It is this very orthodoxy that should give any demand-deficiency-deniers who may still be out there pause.