Fiscal policy

By Eswar Prasad and Karim Foda

The world economy is showing scattered signs of vigor but remains on life support, mostly provided by accommodative central banks. Concerns about spillover from a worsening of the European debt crisis and slowing growth in key emerging markets are putting a damper on consumer and business confidence. Equity markets are pulling back from a robust performance in the first quarter of this year as the sobering reality of a continued anemic recovery weakens investors’ optimism.

There are some positive signs in the latest update of the Brookings Institution-FT Tracking Indices for the Global Economic Recovery (TIGER), but also much to worry about as the world economy continues to meander with no clear sense of direction. Read more

By Thomas I. Palley

In his novel, The Jungle, the American muckraking author Upton Sinclair wrote about the horrendous work and sanitary conditions in the Chicago meat packing industry of the early 20th century. It is sometimes said Sinclair aimed for the heart but hit the stomach. That is because he aimed for progressive social and economic change, but instead his work prompted the founding of the Food and Drug Administration.

The same problem of missing the target confounds current discussions of the eurozone’s problems. What the euro lacks is a government banker, not a lender of last resort as is widely claimed. Read more

By Xhanti Payi

One of the most difficult struggles being fought by those who wish to attract investment into Africa is to destroy the widely held belief that Africa is one big country. Africa in reality is a collection of widely diverse and exciting countries, with varying prospects and challenges.

So apart from the argument that an African Monetary Union (AMU) would be a bad idea if the example of the European Monetary Union is anything to go by, there is a case to be made that a monetary union may interrupt the fight against negative sentiment about Africa that is born out of this that arbitrary aggregate approach. With that said, the idea of an African Monetary Union is a product of history, and arguing against it requires understanding of its context. Read more

By Eswar Prasad and Karim Foda

The world economy has hit a rough patch on the road to recovery and is in danger of skidding off course.

The latest update of the Brookings Institution-FT Tracking Indices for the Global Economic Recovery (TIGER) reveals abundant cause for gloom. The general picture among G20 economies is one of slowing growth, swooning financial markets, and declining consumer and business confidence.

A series of adverse shocks, coupled with political wrangling that has stymied effective policymaking and added to uncertainty, has crippled growth in advanced economies. Emerging markets have maintained strong growth so far, but the battle against domestic inflation and weaknesses in major export markets are beginning to affect their growth as well.

Debt crises, weak employment growth and policy dithering in the major advanced economies have exacerbated global economic uncertainty. The perception of rising risk and inadequate policy responses has shaken financial markets and dented confidence around the world. Reflecting widespread anxiety and fear about global economic prospects and the lack of obvious policy solutions, stock markets around the world have taken a beating over the past summer. Read more

By Thomas I. Palley

The eurozone‘s public finance crisis continues to fester, reflecting both political and intellectual failure. The intellectual failure is that the crisis has been interpreted exclusively as a debt crisis when it is also a central bank design crisis resulting from the euro’s flawed architecture. The flaw is the inability of eurozone governments to harness the central bank’s power to assist government finances. This systemic weakness explains why US and UK government bonds are weathering the storm, whereas Spain confronts default rumours despite having roughly similar debt and deficit profiles. Read more

By Eswar Prasad and Karim Foda

Despite a number of recent shocks, the global economic recovery is getting on to a firmer footing.

The latest update of the Brookings Institution-FT Tracking Indices for the Global Economic Recovery (TIGER) indicates that resurgent job growth and rising business and consumer confidence are solidifying the recoveries in many advanced economies. Emerging markets are still doing well but some of the shine is coming off these economies as they tighten policies to cope with inflationary pressures.

The Overall Growth Index for the G20 economies shows a slight uptick in recent months, led by a gradual rebound in real activity. After the initial post-recession surge, financial markets have pulled back a bit, at least in terms of growth in stock market indexes and valuations. One bright spot is the resurgent business and consumer confidence in both advanced and emerging economies. Read more

By Eswar Prasad and Karim Foda

The October 2010 TIGER update paints a sobering picture of a global economy that has lost momentum and is teetering between a slowdown and at best a tepid recovery. Advanced economies are stuck in a funk and even the dynamic emerging markets have lost some of their swagger.

The Global Financial Index took a beating in 2010 Q2 roughly around the initial period of the European debt crisis and has continued to weaken. Stock markets around the world remain in a state of torpor after a correction that signals a reversal of the optimism that led to their getting ahead—perhaps too far ahead—of improvements in real economic activity.

Credit growth, the latest addition to the TIGER financial (and overall) index, fell sharply towards the end of 2009, but has since begun to rebound, especially in emerging markets. Emerging market bond spreads and the TED spread have remained flat this year indicating that, despite the correction, financial markets are not under huge stress. Read more

It is time to tackle the systemic flaw in housing policy – reliance on leverage – and introduce minimum downpayment regulations for all homebuyers, writes Charles W. Calomiris

Without high leverage the subprime boom and bust could not have happened. Risky no-docs borrowers would have been unwilling to deceive lenders if they had to pledge a large amount of their own savings as a downpayment (deposit). House price declines would not have produced huge loan losses if homeowners had retained a minimum 20 per cent stake in their homes.

During the 1990s and 2000s leverage tolerances on US government-guaranteed mortgages rose steadily and dramatically at FHA, Fannie Mae and Freddie Mac. The average loan-to-value (LTV) ratio of FHA mortgages rose to 96 per cent, and a third of Fannie and Freddie’s purchases leading up to their insolvencies had LTVs of greater than 95 per cent.

Not only are high LTVs destabilising, they undermine the objectives of housing policy. Its central goal is promoting stronger communities by encouraging residents to have a stake in them. But a 97 per cent LTV creates a trivial stake; homeowners become renters in disguise, able to abandon homes at little cost. Read more

Shankar Acharya

These are uncertain times for global economic governance. For over six decades after the second world war the west framed the rules of engagement for the global economy.

In the initial years, the United States was the preeminent power, which oversaw the creation of the Bretton Woods system (International Monetary Fund and World Bank) and the initial rounds of trade liberalization under the newly-born General Agreement on Tariffs and Trade (which became the World Trade Organization at the end of the Uruguay Round in 1993).

As Europe recovered from the ravages of war and Japan launched on its high growth phase, these new leviathans (especially Europe) increasingly asserted themselves and won greater voice and roles in world economic governance. But it was still an essentially western enterprise, with a demilitarized Japan content to go along in return for an American nuclear umbrella.

The Soviet Union and its satellites were not an integral part of this economic system and the developing countries didn’t carry significant economic clout, not even the populous Asian giants of China and India. Read more

By Brendan Brown

There is a magic monetary wand out there which could accelerate economies along the road to prosperity out of the widespread destruction wrought by the global credit bubble.

This wand is not the creation of another monetary time-bomb labelled “quantitative easing”; rather the source of magic is an emergency conversion of banknotes. Read more

By Eswar Prasad and Karim Foda

Despite all the portents of doom the world economy has been quietly mending itself.

This is not to say that the recovery is firmly entrenched or that few risks remain, but despite the rough patches in 2010, it is important to keep in mind that the economic picture looks far better now than it did a year ago. Read more

By Kevin P. Gallagher

At the recent annual meeting of the Asian Development Bank Taiwan’s Central Bank governor Perng Fai-nan urged emerging market nations in Asia to use capital controls to promote financial stability.

Yesterday, this call was echoed by Noeleen Heyzer, executive secretary of the United Nations Economic and Social Commission for Asia and the Pacific. She singled out China, India, Singapore, Indonesia and South Korea as the most vulnerable nations in need of controls

These statements would have been unthinkable a decade ago, and shows how much has changed.

Part of the stigma attached to capital controls has been dampened by the new tune at the International Monetary Fund (IMF). In a February 2010 staff position note and in the IMF‘s Global Financial Stability Report (GSFR) the IMF said that capital controls are a legitimate part of the toolkit for emerging markets. What’s more, the IMF’s economists found that those countries that deployed capital controls in the run-up to the current crisis were among the least hard hit from the global financial crisis.

It is time for the debate over capital controls to shift from whether to deploy controls to how and when.

The problem is that many of the world’s trade and investment treaties, especially those with the US, make it very difficult to effectively use capital controls. Read more

Shankar Acharya

In March the Reserve Bank of India (RBI) published the balance of payments data for the October-December quarter of 2009. It elicited surprisingly little comment. Surprising, because for the second quarter in a row the current account deficit was well above 3 per cent of GDP. Read more

By Michael Pomerleano

Developing and developed countries alike are inextricably connected in the international financial system. Yet this system is heading into strong headwinds and a dangerous period in which vulnerabilities will increase in the international financial system. Read more

By Kevin P. Gallagher

Clear and consistent proposals toward crisis recovery and prevention are needed at the International Monetary Fund upcoming annual meetings. Unfortunately, the IMF has been sending mixed messages over the past two months on the subject of capital controls. Read more

Anybody who looks carefully at the world economy will recognise that a degree of monetary and fiscal stimulus unprecedented in peacetime is all that is prodding it along, not only in high-income countries, but also in big emerging ones. The conventional wisdom is that it will also be possible to manage a smooth exit. Nothing seems less likely. So let us consider the endgame, instead.

The remainder of this column can be read here. Please post comments below.

The bogeyman of a hung parliament is being used to terrify British voters. What is needed, it is argued, is a government with a strong majority, to rescue the UK from the threat of national bankruptcy. This is nonsense. The UK does not face national bankruptcy and, if it did, would not need strong single party government to save it. Has everybody forgotten that in the gravest crisis ever faced by the UK, Winston Churchill governed with a coalition? Why is the present crisis so very different? So poorly has single-party despotism governed the UK that I would welcome a coalition or, at worst, a minority government.

No serious person denies that the country confronts a huge fiscal challenge. Among those serious people are, of course, the leadership of the Liberal Democrats. I cannot be the only person who believes that Vince Cable, the party’s shadow chancellor, is far better qualified to address this challenge than any current member of the Conservative front bench. Indeed, the latter has blown worryingly hot and cold over its elusive plans for fiscal stringency. Read more

So what did I make of this year’s annual meeting of the World Economic Forum at Davos? It felt like sitting at the bedside of somebody who had survived a heart attack but was unsure how long it would take to recover full vigour, if, indeed, he would at all. The mood of “Davos men” (yes, they mostly still are) was, as my colleague, Gideon Rachman, has pointed out, one of anxiety. Meanwhile, the participants in a still predominantly western meeting looked at the youthful vigour of emerging economies with admiration, envy and even fear.

For me, the highlight of the programme was the economic outlook session on Saturday.* This is not only because I was moderator. The starting point for the discussion was an obvious one: the policy interventions of late 2008 and 2009 have been a resounding success. The outcome has been a far briefer and shallower recession than most participants imagined a year ago. That is obvious from the successive consensus of forecasts for 2010. For almost every significant economy, the forecast for growth this year is higher than it was a year or even six months ago (see charts). The world economy survived the heart attack in the financial system. Read more

By Roger E.A. Farmer

For the past nine months I have been presenting some new ideas at academic conferences where economists have been grappling with the current financial crisis. Boston, Montreal, Amsterdam, London, Cleveland, Sydney, Atlanta … Only the venues change.  The participants and the papers are always the same. Read more

By Michael Pomerleano and Andrew Sheng

As the Financial Crisis Inquiry Commission begins looking at the causes of the recent financial crisis, we need to consider that crisis is a failure of governance. Lucian Bebchuk from Harvard Law School has written extensively on the failure of private sector governance: boards that failed to make informed judgments or control the risks incurred by their institutions, self-serving management that lost control over reckless risk taking and compensation systems that invited speculation by traders. Although Sheila Bair, chair of the Federal Deposit Insurance Corporation (FDIC), has openly expressed her discontent with the governance of the banks and the FDIC is considering tying premiums to compensation, we are likely to witness the largest bonus season the industry has ever seen. Read more