Defining a proto-depression

My good friend, Stephen Roach, Asia chairman of Morgan Stanley, disappointed me at the economic outlook session this morning. I expected him to be even more bearish than usual.It says something about the change in global mood that his forecast – a global recession this year followed by 2.5 per cent annual growth over the subsequent three years – looks almost bullish. The reality might be even worse, alas.

I chided him and his fellow panellists for their apparent complacency about what I called a “proto-depression”. What did I mean by this?

I meant that if current rates of decline of gross domestic product in some major economies continued, it is at least possible to imagine peak to trough falls in gross domestic product of 5-10 per cent, even in some advanced countries.

That would be a depression, by any reasonable standard, though no precise definition of that term, of course, exists.

Against this background, surely very determined action is needed to stabilise economies. Yet two panellists – Trevor Manuel, South Africa’s admirable finance minister, and Heizo Takenaka, who rescued Japan’s financial system and economy under prime minister Koizumi, – seemed to question the wisdom of big fiscal packages.

This is surprising. When the private sector is slashing spending, as now, government must take its place, as Keynes argued. In Japan’s case, I would argue strongly that the fiscal deficits of the 1990s prevented a true depression. The same should apply to the entire world even more now.

Justin Lin, the Chinese chief economist of the World Bank, got the needed policy package about right: a global stimulus package, with assistance from developed countries to developing countries that would allow the latter also to stabilise their economies.

There was disappointingly limited discussion at this session of the need for bank reconstruction. But Steve had a strong view that the TARP should be used to buy up toxic assets from banks. Well, a banker would, wouldn’t he?

Taxpayers should take these “toxic” assets off the hands of banks only at bargain basement levels. Would the latter then sell?

The crucial thing is to ensure recapitalisation of the relatively healthy bits of the banking system and transparency of bank balance sheets, but without providing subsidies to bad management and to shareholders of bad banks.

Martin Wolf is associate editor and chief economics commentator of the Financial Times

Davos blog 2009

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