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By Hossein Askari and Noureddine Krichene
The Group of 20 (G-20) countries, in their response to the financial crisis
during 2008-2009, adopted highly expansionary fiscal and monetary policies to
re-inflate their economies out of the crisis, fought any form of deflation, and
prevented market adjustment of speculative asset prices or bubbles.
Even though there were no signs of another Great Depression, the G-20 put in
place policies to fight a repeat of the downturn in the 1930s. Looking ahead,
the group has strongly reiterated that there can be no exit from
crisis-fighting policies until the crisis is over and economic recovery has
been fully established. But can we escape from the economic crisis before we
abandon these policies, which in themselves may have caused the problem in the
first place?
The G-20 has all along misunderstood the monetary causes of the
financial and economic crisis, and as a result has re-invigorated the same
policies that had led to large-scale bankruptcies, massive bailouts and
unemployment rates past 10% in the United States and Europe. The group adopted
the position that the financial crisis was the result of regulatory lapses and
discounted the role of the US Federal Reserve and other reserve currency
central banks in pushing loose monetary policies that in retrospect proved to
be devastating for banks, exacerbating government budget deficits, and stalling
the world economy.
The apparent conviction of the G-20 was that the more governments spend, the
greater the multiplier effect, and therefore the greater the economic growth.
In a similar vein, with near-zero interest rates, they must have decided that
the more consumers borrow and spend, the more output will be produced, and more
employment and prosperity will be on the way. Thus the policy recipe would
appear to be to keep interest rates near zero bound, lend unconditionally to
borrowers, expand the money supply with little consideration of all of the
other consequences, with the expectation that economic bliss will soon follow,
as indicated by the Barack Obama administration’s prediction that the US
unemployment would peak at 8% and then decline.
At the outset, this strategy as stated in G-20 communiques looked simple and
salutatory, calling on the G-20 to monitor member countries' performance in
line with the expansionary directives of the group. At the same time, the G-20
extended US$1 trillion in loans to developing countries so that they could
expand their fiscal profligacy and also adopt unorthodox policies without undue
external constraint.
As with everything else in this day and age, unorthodox policies were
globalized. The G-20 seemed to assume that these policies were as innocuous as
in the past and that their implementation would be smooth and simple, with full
confidence that they would achieve fast recovery and return to full employment.
Recovery and gains in employment have been anything but rapid, as the
disorderly nature of unorthodox monetary policies is still unraveling. The G-20
did not anticipate or appreciate the causes of the debt crisis that was about
to erupt in Greece, with a number of other countries not far behind. When debt
finances government consumption instead of investment or capital formation,
there is no additional income generated to service the debt. Without additional
income and revenues, the normal consequence is default.
The G-20 seems to have missed the crucial point that a number of significant
countries had unsustainable public debt based on very cheap borrowing as a
result of low global interest rates, and they were already running large fiscal
and external imbalances. Further increases in their fiscal deficits were
certain to compromise their debt-servicing capacity and cause a debt crisis
similar to the problem facing Greece today.
Even if a country prints money to finance its fiscal deficits, such as those of
the United Kingdom and the United States at 13% of gross domestic product (GDP)
in 2009-2010, the economic consequences are likely to be disruptive. In fact,
in spite of monumental fiscal deficits, the UK's real GDP contracted by 5% in
2009 and unemployment rose to 9%. The monetary financing of the deficits
re-ignited inflation and sent the UK pound tumbling to new lows.
Similarly, the US fiscal deficits at 13% of GDP in 2009 and 2010 have failed to
turn around the economy; real GDP contracted by 2.4% in 2009 and official
unemployment accelerated to 10% in 2009 from 4.3% in 2007, despite large-scale
stimuli spending initiated since April 2008. In many other European countries,
record fiscal deficits and loose monetary policies did not prevent real GDP
contraction and a deterioration of the unemployment picture in 2009.
Are unlimited government expenditures the appropriate instrument for reversing
recession? Keynesian academics seem invariably to call for an increase in
government spending to address the problem. Although government expenditures
are essential for economic growth and stability, in areas such as
infrastructure, education, healthcare, security, and public services, there is
a limit that can be effectively absorbed and should not be exceeded to avoid
unproductive expenditures and compromising economic growth.
Moreover, it should be emphasized that government expenditures are extremely
inflexible in the downward direction and are invariably politically, as opposed
to economically, motivated. For example, while expenditures may be increased
almost instantaneously by raising the salaries of public servants or
introducing inefficient and unproductive spending, they are extremely difficult
to roll back, as they necessarily imply layoffs and/or eliminate benefits
enjoyed by powerful interest groups.
For these reasons, sustainability, efficiency, and social equity are important
when it comes to using public spending to fight cyclical economic developments.
Besides failing to comprehend the magnitude of the fiscal imbalances that are
now constraining the economies of a number of countries, the G-20 has failed to
recognize the devastating effects of the excessively loose monetary policies
initiated since 2001 by reserve currency central banks - bankrupting banks with
the number of problem lenders still rising, distorting economic conditions with
low interest rates, fueling speculation in housing and energy and food sectors,
and resulting in enormous bailout costs which still have to be absorbed in
government budgets.
The G-20 assumed that everything would resume as before. They simply ignored
these effects and took for granted that banks would again start lending money
as they did before the crisis to all manner of borrowers, including consumers,
governments, and corporations, regardless of risk and profitability.
On the other hand, the G-20 did not appear to give much support for policies
that would restore fiscal discipline and orthodox and safe monetary policy.
Ostensibly, the curtailing of the US fiscal deficits in 1997-2000 and the
re-emergence of fiscal surpluses enabled a strong economic growth at about
4.5-4.8% rate and pushed unemployment to a low level at 3.8% of the labor
force. But a number of countries that experienced loose fiscal and monetary
policies were not able to regain economic growth until they had governments
that restored fiscal and monetary discipline.
Near-zero interest rates implemented by major reserve banks since December 2008
failed to re-activate lending. Similar rates implemented in Japan since the
mid-1990s have failed to re-activate the economy; instead they kept the
Japanese economy in a state of protracted stagnation until today. Central
banks, including the Bank of Japan, did not try to understand why near-zero
interest rates were not effective in a post-crisis period to spur lending and
re-animate the economy. They decided that low rates had to be supplemented by
powerful quantitative easing by central banks, which consists of bypassing the
banking system, lending directly to subprime markets, and purchasing toxic
assets from banks.
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