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How to Prevent a Depression
AMSTERDAM "“ The latest economic data suggests that recession is returning to most advanced economies, with financial markets now reaching levels of stress unseen since the collapse of Lehman Brothers in 2008. The risks of an economic and financial crisis even worse than the previous one "“ now involving not just the private sector, but also near-insolvent sovereigns "“ are significant. So, what can be done to minimize the fallout of another economic contraction and prevent a deeper depression and financial meltdown?
First, we must accept that austerity measures, necessary to avoid a fiscal train wreck, have recessionary effects on output. So, if countries in the eurozone's periphery are forced to undertake fiscal austerity, countries able to provide short-term stimulus should do so and postpone their own austerity efforts. These countries include the United States, the United Kingdom, Germany, the core of the eurozone, and Japan. Infrastructure banks that finance needed public infrastructure should be created as well.
Second, while monetary policy has limited impact when the problems are excessive debt and insolvency rather than illiquidity, credit easing, rather than just quantitative easing, can be helpful. The European Central Bank should reverse its mistaken decision to hike interest rates. More monetary and credit easing is also required for the US Federal Reserve, the Bank of Japan, the Bank of England, and the Swiss National Bank. Inflation will soon be the last problem that central banks will fear, as renewed slack in goods, labor, real estate, and commodity markets feeds disinflationary pressures.
Third, to restore credit growth, eurozone banks and banking systems that are under-capitalized should be strengthened with public financing in a European Union-wide program. To avoid an additional credit crunch as banks deleverage, banks should be given some short-term forbearance on capital and liquidity requirements. Also, since the US and EU financial systems remain unlikely to provide credit to small and medium-size enterprises, direct government provision of credit to solvent but illiquid SMEs is essential.
Fourth, large-scale liquidity provision for solvent governments is necessary to avoid a spike in spreads and loss of market access that would turn illiquidity into insolvency. Even with policy changes, it takes time for governments to restore their credibility. Until then, markets will keep pressure on sovereign spreads, making a self-fulfilling crisis likely.
Today, Spain and Italy are at risk of losing market access. Official resources need to be tripled "“ through a larger European Financial Stability Facility (EFSF), Eurobonds, or massive ECB action "“ to avoid a disastrous run on these sovereigns.
Fifth, debt burdens that cannot be eased by growth, savings, or inflation must be rendered sustainable through orderly debt restructuring, debt reduction, and conversion of debt into equity. This needs to be carried out for insolvent governments, households, and financial institutions alike.
Sixth, even if Greece and other peripheral eurozone countries are given significant debt relief, economic growth will not resume until competitiveness is restored. And, without a rapid return to growth, more defaults "“ and social turmoil "“ cannot be avoided.
There are three options for restoring competitiveness within the eurozone, all requiring a real depreciation "“ and none of which is viable:
· A sharp weakening of the euro towards parity with the US dollar, which is unlikely, as the US is weak, too.
· A rapid reduction in unit labor costs, via acceleration of structural reform and productivity growth relative to wage growth, is also unlikely, as that process took 15 years to restore competitiveness to Germany.
· A five-year cumulative 30% deflation in prices and wages "“ in Greece, for example "“ which would mean five years of deepening and socially unacceptable depression; even if feasible, this amount of deflation would exacerbate insolvency, given a 30% increase in the real value of debt.
Because these options cannot work, the sole alternative is an exit from the eurozone by Greece and some other current members. Only a return to a national currency "“ and a sharp depreciation of that currency "“ can restore competitiveness and growth.
Leaving the common currency would, of course, threaten collateral damage for the exiting country and raise the risk of contagion for other weak eurozone members. The balance-sheet effects on euro debts caused by the depreciation of the new national currency would thus have to be handled through an orderly and negotiated conversion of euro liabilities into the new national currencies. Appropriate use of official resources, including for recapitalization of eurozone banks, would be needed to limit collateral damage and contagion.
Seventh, the reasons for advanced economies' high unemployment and anemic growth are structural, including the rise of competitive emerging markets. The appropriate response to such massive changes is not protectionism. Instead, the advanced economies need a medium-term plan to restore competitiveness and jobs via massive new investments in high-quality education, job training and human-capital improvements, infrastructure, and alternative/renewable energy. Only such a program can provide workers in advanced economies with the tools needed to compete globally.
Eighth, emerging-market economies have more policy tools left than advanced economies do, and they should ease monetary and fiscal policy. The International Monetary Fund and the World Bank can serve as lender of last resort to emerging markets at risk of losing market access, conditional on appropriate policy reforms. And countries, like China, that rely excessively on net exports for growth should accelerate reforms, including more rapid currency appreciation, in order to boost domestic demand and consumption.
The risks ahead are not just of a mild double-dip recession, but of a severe contraction that could turn into Great Depression II, especially if the eurozone crisis becomes disorderly and leads to a global financial meltdown. Wrong-headed policies during the first Great Depression led to trade and currency wars, disorderly debt defaults, deflation, rising income and wealth inequality, poverty, desperation, and social and political instability that eventually led to the rise of authoritarian regimes and World War II. The best way to avoid the risk of repeating such a sequence is bold and aggressive global policy action now.
Nouriel Roubini is Chairman of Roubini Global Economics, Professor of Economics at the Stern School of Business, New York University, and co-author of the book Crisis Economics.
Copyright: Project Syndicate, 2011. www.project-syndicate.org
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Username Password New registration Forgotten password slightly_optimistic 03:41 19 Sep 11
"the advanced economies need a medium-term plan to restore competitiveness and jobs"
The 'Economist' this month published a special report on the future of employment. Unemployment is likely to remain high in the rich economies. Globalisation and technological innovation are bringing about long-term changes in the world economy that are altering the structure of the labour market.
The McKinsey Global Institute in the US says there are three main types of work: physical, clerical and interactional (relying on knowledge, expertise and collaboration with others, such as investment banking or management consultancy). Physical has long been going to emerging markets, clerical is now going, but interactional is likely to stay and earn big profits. Expect national, never mind international, ructions in the short-term especially caused by high youth unemployment.
The presidency of the European Union suggests that unemployment might double in two years with a continental war breaking out within ten years.
The answers are thought to be better education, further deregulation and infinite patience. A sustainable solution?
akis 03:47 19 Sep 11Very well said. An important contribution to enlarge the visions of some western politicians and elites, who have responsibility for the current economic collapse. However, I think the potential role of IMF and WB has been exaggerated. Simply because, the performances of these two Bretton Woods organisations, to reduce the magnitude of the current economic crisis and of the ongoing human drama in Africa, are obvious. They are simply inefficient and ineffective. In my opinion these organisations, are nothing but a kind of projections of the current economic depression, onto some other plane.
Pasquino 06:15 19 Sep 11A pilot confronted with a stall situation shouldn't seize on it as an opportunity to save money on fuel. Fuel saved, plane lost, passengers dead.This is exactly what the austerity measures being pressed in the major economies are bound to do. You have to assume the decisions are being made by executives who are not on the aircraft. Who do not own the aircraft. Who, perhaps, own hedge positions on the demise of the aircraft.To choose another analogy, austerity measures in a financial downturn are the modern equivalent of medieval physicians bleeding a patient. It didn't save any patients, and killed many, but the doctors were paid for their efforts.
lguerra10 06:18 19 Sep 11Global competition with current rules is not going to work for advanced economies to maintain employment and living standards of middle income families. Competition is bad for the losers, and advanced economies have been the losers in the last decade.
We need to change the rules of the “global competition” game. Dani Rodri says as much in his latest book while stopping short of recognizing that protectionism is going to be required.
Education does not work. We have in Spain thousands of college graduates unemployed or underemployed doing manual or clerical work. Education is what politicians and many economists sell to the unemployed, but it does not solve the problem.
The Governments of advanced economies need to regain control of the game, corporations, big money, banks, etc. so that they can really help with unemployment and income distribution. Protectionism will be required. It is no good that a company will move production to another country and keep selling in the market without paying for it.
May be we will need some kind of “local production content” if you want access to the market.
slightly_optimistic 07:23 19 Sep 11Why unsustainable solutions [#1]? There seems to be a huge conflict of interest impeding national job creation; illustrated today in <a href="http://prestowitz.foreignpolicy.com/posts/2011/09/19/jeff_immelt_and_the_american_dream">this link</a> .
AUTHOR INFO Nouriel Roubini Nouriel Roubini is Chairman of Roubini Global Economics, Professor of Economics at the Stern School of Business, New York University, and co-author of the book Crisis Economics. MOST READ MOST RECOMMENDED MOST COMMENTED The Great Bank Robbery Nassim Nicholas Taleb and Mark Spitznagel The Price of 9/11 Joseph E. Stiglitz The Economics of Happiness Jeffrey D. Sachs Europe on the Verge of a Political Breakdown Barry Eichengreen The Keynes-Hayek Rematch Robert Skidelsky A New World Architecture George Soros Did the Poor Cause the Crisis? Simon Johnson No Time for a Trade War Joseph E. Stiglitz The Second Great Contraction Kenneth Rogoff America's Political Class Struggle Jeffrey D. Sachs The Great Bank Robbery Nassim Nicholas Taleb and Mark Spitznagel The Price of 9/11 Joseph E. Stiglitz Divided We Fall Gordon Brown Thinking the Unthinkable in Europe George Soros Europe on the Verge of a Political Breakdown Barry Eichengreen ADVERTISEMENT PROJECT SYNDICATEProject Syndicate: the world's pre-eminent source of original op-ed commentaries. A unique collaboration of distinguished opinion makers from every corner of the globe, Project Syndicate provides incisive perspectives on our changing world by those who are shaping its politics, economics, science, and culture. Exclusive, trenchant, unparalleled in scope and depth: Project Syndicate is truly A World of Ideas.
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"the advanced economies need a medium-term plan to restore competitiveness and jobs"
The 'Economist' this month published a special report on the future of employment. Unemployment is likely to remain high in the rich economies. Globalisation and technological innovation are bringing about long-term changes in the world economy that are altering the structure of the labour market.
The McKinsey Global Institute in the US says there are three main types of work: physical, clerical and interactional (relying on knowledge, expertise and collaboration with others, such as investment banking or management consultancy). Physical has long been going to emerging markets, clerical is now going, but interactional is likely to stay and earn big profits. Expect national, never mind international, ructions in the short-term especially caused by high youth unemployment.
The presidency of the European Union suggests that unemployment might double in two years with a continental war breaking out within ten years.
The answers are thought to be better education, further deregulation and infinite patience. A sustainable solution?
Very well said. An important contribution to enlarge the visions of some western politicians and elites, who have responsibility for the current economic collapse. However, I think the potential role of IMF and WB has been exaggerated. Simply because, the performances of these two Bretton Woods organisations, to reduce the magnitude of the current economic crisis and of the ongoing human drama in Africa, are obvious. They are simply inefficient and ineffective. In my opinion these organisations, are nothing but a kind of projections of the current economic depression, onto some other plane.
A pilot confronted with a stall situation shouldn't seize on it as an opportunity to save money on fuel. Fuel saved, plane lost, passengers dead.This is exactly what the austerity measures being pressed in the major economies are bound to do. You have to assume the decisions are being made by executives who are not on the aircraft. Who do not own the aircraft. Who, perhaps, own hedge positions on the demise of the aircraft.To choose another analogy, austerity measures in a financial downturn are the modern equivalent of medieval physicians bleeding a patient. It didn't save any patients, and killed many, but the doctors were paid for their efforts.
Global competition with current rules is not going to work for advanced economies to maintain employment and living standards of middle income families. Competition is bad for the losers, and advanced economies have been the losers in the last decade.
We need to change the rules of the “global competition” game. Dani Rodri says as much in his latest book while stopping short of recognizing that protectionism is going to be required.
Education does not work. We have in Spain thousands of college graduates unemployed or underemployed doing manual or clerical work. Education is what politicians and many economists sell to the unemployed, but it does not solve the problem.
The Governments of advanced economies need to regain control of the game, corporations, big money, banks, etc. so that they can really help with unemployment and income distribution. Protectionism will be required. It is no good that a company will move production to another country and keep selling in the market without paying for it.
May be we will need some kind of “local production content” if you want access to the market.
Why unsustainable solutions [#1]? There seems to be a huge conflict of interest impeding national job creation; illustrated today in <a href="http://prestowitz.foreignpolicy.com/posts/2011/09/19/jeff_immelt_and_the_american_dream">this link</a> .
Project Syndicate: the world's pre-eminent source of original op-ed commentaries. A unique collaboration of distinguished opinion makers from every corner of the globe, Project Syndicate provides incisive perspectives on our changing world by those who are shaping its politics, economics, science, and culture. Exclusive, trenchant, unparalleled in scope and depth: Project Syndicate is truly A World of Ideas.
Project Syndicate provides the world's foremost newspapers with exclusive commentaries by prominent leaders and opinion makers. It currently offers 54 monthly series and one weekly series of columns on topics ranging from economics to international affairs to science and philosophy.
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