When G20 Leaders met in April 2009 they agreed on coordinated fiscal stimulus in response to the unfolding financial crisis. This explicit coordination addressed the concern that any one country’s stimulus would largely flow overseas through the external account, benefitting the global economy but not doing much to boost domestic demand. This concerted stimulus seems to have been successful. In the face of a dramatic collapse in financial systems in much of the advanced world the fiscal stimulus put a floor under contracting GDP. The People’s Republic of China’s (PRC) huge stimulus produced a swift return to 10% growth in 2010.
For all its apparent success, this high point of international policy coordination was brief, not to be continued or repeated. The nature of the economic problems changed. More importantly, perceptions of policy options shifted sharply. G20 put in place a mechanism for encouraging continuing policy coordination, but the practical outcome has been marginal. What happened to cause this change?
Reverberations of the Greek debt debacle
A key event was the Greek debt debacle in early 2010. Greece itself is small in the global picture, but concerns about contagion focused attention on debt sustainability in the European peripheral countries. Just as important, it raised debt concerns across all the advanced economies. The central issue was no longer fiscal stimulus, but fiscal contraction and public debt consolidation.
This fiscal contraction was not seen to require any coordination or mutual endorsement. Unanimity was high among national policy-makers and the general retreat to fiscal contraction was strongly endorsed by all the international agencies (IMF, OECD, BIS). Countries just went ahead as quickly as their domestic political circumstances would allow, without much consideration of possible spill-overs. No one saw any need to coordinate or moderate the speed of contraction, least of all the IMF which at this stage saw little negative impact of the contraction on activity. Fiscal multipliers were estimated to be small, and as a result forecasts of the recovery profile proved uniformly over-optimistic.
The focus of international coordination shifted to external imbalances. This was not a new issue. As early as 2005, then Fed board member (later chairman) Ben Bernanke (2005) had identified global imbalances in general—and the PRC’s external surplus in particular—as a global problem which needed resolving. Bernanke (and others) blamed global imbalances for America’s pre-crisis external deficit, weak demand and the low interest rates. These low interest rates facilitated the sub-prime borrowing which later triggered the wider financial crisis. In fact when Bernanke spoke the US deficit was already over 5% of GDP, but the PRC was only a small part of the global surplus. By 2007, however, the PRC’s surplus had risen to 10% of its GDP and formed the core of the US argument that the PRC was pursuing an export-oriented growth strategy, to the disadvantage of the global economy. Thus entering the global financial crisis the focus of international coordination was both fiscal policy and external imbalances.
This focus on external imbalances was reflected in the technical inputs into the G20 meetings, especially the Mutual Assessment Program. Of course the discussion ranged more widely than simply the external imbalances, but judging by the background material, the general discussion (IMF 2013a) was less important than the imbalances (IMF 2013b).
Intractable global imbalances
This focus on external imbalances has been overtaken by events. The PRC’s surplus fell from 10% of GDP in 2007 to 2.5% in 2013 and the yuan appreciated substantially. America’s external deficit has fallen also, and the deeper behavioral relationships behind the deficit have changed markedly. The remaining global imbalances are intractable. The oil producers remain in surplus, as does Germany. But there is little more to be said in the policy discussion: Germany has followed the universal shift to fiscal contraction. If Germany had its own national currency, currency appreciation would almost certainly have weakened its international competitiveness, but with the euro held down by problems elsewhere in the euro-area, the exchange rate reinforces German’s intrinsically-strong international competitiveness.
In any case the global macro issues have shifted. Rather than external imbalances, the main issues are now:
- How to achieve the appropriate pace of fiscal consolidation, addressing the issue of excessive government debt without weakening the feeble pace of global recovery.
- How to unwind the unconventional monetary policies (such as US quantitative easing) currently in place in a number of advanced economies without the external spillover harming other countries, particularly the emerging economies.
- Related to this, how to reduce the volatile surges and retreats of global capital flows, particularly into and from the emerging economies.
- How to resolve the unsustainable debt burden of the European peripheral countries.
- How to strengthen financial sectors, not only to ensure that there is no repeat of the 2008 global financial crisis, but to ensure that the financial sector performs its important role more efficiently than it did in the decade before the crisis.
This set of issues would make an exciting and worthwhile agenda. For different reasons, however, there is unlikely to be substantive discussion on any of these topics.
Fiscal consolidation is such a fraught issue in the major countries that it is effectively off the agenda. The US has no interest in bringing its domestic political problems to an international forum; the UK has given strong push-back to the IMF’s attempt to encourage a less contractionary policy; and Germany is not ready to initiate more accommodative policies.
It is clear that the unwinding of US quantitative easing (QE) policy is of major concern to financial markets, and the mere mention of the possibility of QE tapering in May this year triggered sharp capital outflows and exchange rate falls in several emerging economies. The emerging countries can complain about this at G20, but there will be no substantive discussion. Brazil’s complaints about ‘currency wars’ went unheeded, and when Japan introduced its unconventional monetary policies early in 2013, the G7 countries designated this as a domestic issue, despite the huge impact this had on the value of the yen. By the time the discussion gets to the G20, it has been ‘predigested’ in G7 to rob it of any policy-making content.
One aspect of the international debate has shifted in a useful direction since the 2008 global financial crisis. Reflecting advanced country consensus, the IMF had previously opposed any efforts to managed external capital flows. Over the past couple of years, however, the Fund has come to accept that there may be circumstances, when other policies prove inadequate, for managing capital flows. This endorsement is tentative, without much practical guidance on how this should be done. But at least the topic is no longer off limits. It might usefully be developed further. This would, however, require a sponsor to initiate and motivate the discussion, and this has not yet happened.
The debt burden of the European peripheral countries is unsustainable and acts as a deadweight on euro-area growth, but Europe continues to treat this as its own internal issue (despite the heavy IMF support involved), inhibiting any policy discussion in G20 forums.
How to fix the financial system
There has been no shortage of international discussion on how to fix the financial system. G20 enlarged the existing Financial Stability Forum to become the Financial Stability Board and the Bank for International Settlements has been an effective policy forum. There has been progress in the form of additional capital requirements. The push-back from Wall Street has, however, been formidable. Initiatives to separate conventional banking from more risky aspects (investment banking and proprietary trading) may trip up on the morass of red tape and regulation, and the dangers inherent in the shadow banking sector remain largely unaddressed. In any case, these operational issues have gravitated into the domestic policy sphere, with countries making their own rules. Indeed, it is not clear that ‘one size fits all’ rules are a desirable goal. Prudential supervision will operate successfully while the memory of the 2008 debacle remains strong, but this will fade with time. It looks like the opportunity to make decisive changes (which would result in a much smaller, simpler financial sector) seems to have been lost.
The extent and severity of the 2008 global financial crisis created an opportunity to foster international policy coordination and perhaps establish this as a vital ongoing process, providing G20 with a solid rationale and substance for regular high-level meetings. Now, five years later, the substance of international policy coordination has not taken firm root and the opportunity is, for the moment at least, dormant. Just as all politics is local, most economics is domestic.
Bernanke, Ben. 2005. The Global Saving Glut and the U.S. Current Account Deficit. Speech delivered at the Sandridge Lecture, Virginia Association of Economists. Richmond, Virginia. 10 March.
IMF. 2013a. Update on Global Prospects and Policy Challenges. St. Petersburg, Russia, G-20 Leaders Summit. Washington, DC.
IMF. 2013b. Update of Staff Sustainability Assessments for G-20 Mutual Assessment Process (MAP). Washington, DC.