Why the G-20 Finance Ministers Are Wrong
Finance ministers and central-bank governors of the Group of 20 major economies are in Washington for their semi-annual discussion of the world’s dismal economic prospects. The prediction for output and jobs, catalogued in forecasts prepared for their meeting, is unacceptable. It’s also avoidable, if leaders in the U.S. and especially the European Union rethink their policies.
In its latest forecast, the International Monetary Fund says it expects the world economy to grow by a feeble 3.3 percent this year -- a cut of 0.2 percentage point from its previous projection. It foresees weak performance in all the advanced economies. Japan, where policy has just been radically changed, is a partial exception.
Inured as we all are to economic disappointment, these numbers still make depressing reading. With unemployment remaining far too high at 7.6 percent, the U.S. is projected to expand only 1.9 percent in 2013, down from 2.2 percent last year.
In the euro area, things are much worse. Europe is facing another year of contraction, with output falling 0.3 percent in 2013 following a decline of 0.6 percent last year.
Japan, by these standards, is a bright spot. It’s just adopted a new economic policy centered on unorthodox (and long overdue) monetary stimulus that may improve its prospects: The IMF expects growth of 1.6 percent this year, still low but an improvement of 0.4 percentage point over the previous projection -- and an expansion of 3.8 percent is predicted fourth quarter on fourth quarter.
The point is, policy makes a difference. This global recovery was always going to be slow by historical standards, since it follows a crash brought on by a massive financial breakdown -- a so-called balance-sheet recession. Consumers in many economies still don’t want to spend; they’re busy paying down mortgages and credit-card debt. While this deleveraging proceeds, growth will be slow. But it doesn’t need to be as slow as this.
Premature fiscal contraction is under way in the U.S. If Congress and the White House could agree on a credible plan for medium-term consolidation, fiscal policy could safely stay easy in the short term.
The Barack Obama administration’s new budget proposal implicitly recognizes this: It suggests a slight relaxing of the short-term fiscal stance, relative to the plans being fitfully debated on Capitol Hill. Congress looks unwilling to go along, and the prospects for restoring short-term fiscal stimulus seem close to nil -- leaving the whole burden of providing support for demand on an overstretched Federal Reserve. The recovery will be slower, unemployment will stay elevated and the risk of future financial reverses will be higher as a result.
In the EU, fiscal policy is locked in severe-austerity mode, especially in the weakest economies, because of the euro area’s failure to pool its budgetary resources. The reluctance of German and other northern European taxpayers to support the struggling southerners is understandable. This reluctance, however, is self-defeating, and northern governments are failing in their duty to point this out. The weakest economies are holding back the rest; the southern tier’s troubles could even lead to new financial calamities. Forms of fiscal risk-sharing to support demand in the weakest economies are indispensable -- yet they’re not even on Europe’s agenda.
An extreme instance of this fiscal paralysis is the recent backsliding on plans for a banking union. It’s almost universally agreed that the euro area needs not just a single banking supervisor but also a single authority that can wind down troubled banks, backed by a common resolution fund. This last component is a form of fiscal risk-sharing. Germany and its allies are saying, in effect, no go. This obduracy maintains the fatal link between bank insolvency and state insolvency, leaving unfixed one of the euro area’s most fundamental weaknesses.
The U.S. can look to the Fed to make up for Washington’s fiscal bungling. Europe has no such luck. The European Central Bank continues to hold back from maximum monetary support. It’s inhibited by a needlessly strict interpretation of its price stability mandate -- which the bank’s governing council could tweak at its own initiative -- and by legal constraints on unorthodox measures such as quantitative easing, which governments could relax if they chose. The result is crippling recessions which, for many countries, show no sign of ending.
If the past is any guide, the message from the G-20 finance ministers this weekend will be: We’re making slow but steady progress, and promise to stay the course. The truth is, they’ve set the wrong course, and millions of unemployed in the U.S and Europe are bearing the consequences.
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