By Kenneth Rogoff

As the global economic crisis hits its one year anniversary, it is time to re-examine not just the strategies for dealing with it, but also the diagnosis underlying those strategies. Is it not now clear that the main macroeconomic challenges facing the world today are an excess demand for commodities and an excess supply of financial services? If so, then it is time to stop pump-priming aggregate demand while blocking consolidation and restructuring of the financial system.

The huge spike in global commodity price inflation is prima facie evidence that the global economy is still growing too fast. There is nothing sinister in this. The world has just experienced perhaps the most remarkable growth boom in modern history. Given the huge cumulative rise in global growth during the 2000s it is little wonder that commodity suppliers have found it increasingly difficult to keep up, even with sharply rising prices.

For many commodities, particularly energy and metals, new supply requires long lead times of five to 10 years. In principle, the demand response is more nimble, but it has been greatly dulled by a wide variety of subsidies and distortions in fast-growing emerging markets.

The remainder of this column can be read here. Debate from our panel of economists appears below.

By Lawrence Summers 

Anyone who cares about the health of the US economy should welcome the enactment of the Treasury’s rescue plan for Fannie Mae and Freddie Mac, along with other measures to support the housing market. While there is room for argument about details, the risks to the financial system were too great to allow delay.

No one should suppose, however, that the issue is now satisfactorily resolved, even for the short term. Emergency legislation was necessary because market participants were unwilling to buy Fannie and Freddie’s debt; investors doubted that the government-sponsored enterprises were healthy enough to repay it and did not draw sufficient reassurance from the implicit guarantee of federal support. If their debt proves easier to place now, it is only because this guarantee has been strengthened, not because anything has changed at the GSEs.

The remainder of this column can be read here. Debate from our panel of economists appears below.

By Joseph Stiglitz

Much has been made in recent years of private/public partnerships. The US government is about to embark on another example of such a partnership, in which the private sector takes the profits and the public sector bears the risk. The proposed bail-out of Fannie Mae and Freddie Mac entails the socialisation of risk – with all the long-term adverse implications for moral hazard – from an administration supposedly committed to free-market principles.

Defenders of the bail-out argue that these institutions are too big to be allowed to fail. If that is the case, the government had a responsibility to regulate them so that they would not fail. No insurance company would provide fire insurance without demanding adequate sprinklers; none would leave it to “self-regulation”. But that is what we have done with the financial system.

Even if they are too big to fail, they are not too big to be reorganised. In effect, the administration is indeed proposing a form of financial reorganisation, but one that does not meet the basic tenets of what should constitute such a publicly sponsored scheme.

First, it should be fully transparent, with taxpayers knowing the risks they have assumed and how much has been given to the shareholders and bondholders being bailed out.

The remainder of this column can be read here. Debate from our panel of economists appears below.

By Paul De Grauwe

The financial crisis continues to create victims. Not only people but also some of our most cherished ideas risk falling by the wayside. Take the hugely influential idea that financial markets are efficient. Its proponents told us that when financial markets were left free, they would work miracles. Savings would be channelled to the most promising investment projects, thereby boosting economic growth and welfare. In addition, these financial markets would spread risk around over a large number of participants, thereby lowering the risk of doing business, again boosting growth and welfare. In order to achieve these wonders, financial markets had to be freed from the shackles of government control.

The country that embodied these principles most was the US. Helped by the missionary zeal of successive American administrations and pushed by international financial institutions, country after country freed their financial markets from pernicious government controls, hoping to share in these economic wonders.

The remainder of this column can be read here. Debate from our panel of economists appears below.

by Edmund Phelps

Many people see every downturn of employment from a long-sustained plateau as a fall of aggregate demand - “effective demand” in Keynes’s terms. They would have the central bank cut interest rates to restore that demand.

If employment is down because of aggregate demand, the problem can be addressed at zero cost through rate cuts and the ensuing rise in the money supply. Many central banks like to do that: to “lean against the wind”.

This time, though, there are forebodings of “stagflation” - lower employment without the solace of lower inflation. Some economists instinctively feel that the present downturn is the effect of structural shifts in the economy, not a shift in aggregate demand. They doubt that a central bank should retard effects it cannot prevent.

If employment is down because of shifting structures, gearing the money supply to attempt to prop up employment would generate ever-rising inflation. Inflation expectations would break loose from their moorings and the attempt would fail. Some central banks are refraining from rate cuts.

We have a difference of opinion and of policy. But the structuralist case needs to be argued. What are the primary forces of a structural nature? And, crucially, what are the nonmonetary channels through which these forces have structural impacts on the economy - on the size of the labour force and the natural rate of unemployment?

 The remainder of this post can be read here. Debate from our panel of economists appears below.

by Martin Wolf

It is now almost a year since the US subprime crisis went global. Many then hoped that the repricing of risk would be no more than a brief interruption in the progress of the US and world economies. Such hopes have been disappointed. The woes of Fannie Mae and Freddie Mac, the tumbling stock markets and the climbing oil prices make clear how far the turmoil is from its end. It has, in all likelihood, not even passed the end of its beginning.

So where is the world economy now? And where might it go? Here are some preliminary answers to these questions.

The answer to the first comes in two main parts: continued financial distress and commodity price rises.

The performance of banking stocks tells one most of what one needs to know about the financial crisis. In the US, the epicentre of the distress, banks had lost half of their market value between a year ago and the end of last week, relative to the S&P composite index.

The remainder of this column can be read here. Debate from our panel of economists appears below.

by Ricardo Caballero

Here we go again. Two pillars of the US and world financial system, Fannie Mae and Freddie Mac, have become embroiled in the current financial turmoil. To be sure, nobody in their right mind expects these institutions to stop operating; the issue instead is whether, how and when a government intervention takes place.

Treasury secretary Henry Paulson has just announced a first package of all out support that involves contingent credit and possibly equity. The terms of the latter are yet unclear but they harbor hope that Treasury has realized how dangerous its previous anti-stockholders strategy had become. Only last Friday the rumor had it that Secretary Paulson was insisting that any potential government rescue plan would not benefit the companies’ shareholders. In fact, if he were to continue with the modus operandi he adopted during the recent Bear Stearns intervention, not only shareholders would not benefit, but they would be “exemplarily” punished.

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Something has changed in the debate on man-made climate change: the US is engaged. But its engagement – or at least the engagement of President George W. Bush – is neither enthusiastic nor unconditional. In particular, at discussions among the heads of governments of the Group of Eight leading countries in Japan, Mr Bush stressed that China and India had to participate. In this, he was right: it will be impossible to tackle the problem without the participation of leading emerging countries. The question is on what terms they do so.

This is to ignore the debate on whether man-made climate change is either plausible or correctly assessed. I find the arguments sufficiently cogent to justify action. Above all, I find persuasive the argument of Professor Martin Weitzman of Harvard University that it is worth paying a great deal to eliminate the risk of catastrophe.* Those who reject such views need read no further.

The remainder of this column can be read here. Debate from our panel of economists appears below.

By Martin Wolf

“We told you so.” The Bank for International Settlements has long warned of the dangers of unrestrained credit growth and asset price inflation. In this year’s annual report, the last to be prepared under the direction of William White, its long-serving Canadian economic adviser, it felt free to point out how right it had been. But it did so with restraint: “Rather than seeking to apportion blame,” it says, “thoughtful reactions must be the first priority.”

The report provides just such reactions. But it also describes the mess created by those who ignored its earlier warnings. “The current market turmoil in the world’s main financial centres is,” it claims, “without precedent in the postwar period. With a significant risk of recession in the US, compounded by sharply rising inflation in many countries, fears are building that the global economy might be at some kind of tipping point. These fears are not groundless.”

As readers of BIS annual reports would expect, this one gives good answers to four big questions.

The remainder of this column can be read here. Debate from our expert panel appears below.

By Fred Bergsten

The global economy has clearly decoupled from the US and world growth remains close to 4 per cent in spite of the absence of any increases in domestic US demand. Continued expansion abroad, especially in the emerging market economies, has in fact cushioned the slowdown and so far prevented recession in the US. Hence we are also experiencing the first episode in history of reverse coupling, in which the rest of the world pulls the US forward rather than the opposite.

The most striking feature of the current global economic situation is that the US is the only major country that is seriously contemplating recession and that has adopted aggressive expansionary policies to combat that risk. Most other countries are more worried about inflation than slower growth. Many are experiencing reduced growth, to be sure, but part of their slowing is a natural cyclical reaction to four years of near-record global expansion, at more than 4½ per cent from 2004 to 2007, and the need to focus on price stability. The additional losses because of the housing and credit crises in the US amount only to a couple of 10ths of 1 per cent in most areas, including Europe and Japan. It will reach a full percentage point or more only in the fastest growers such as China, where expansion will remain near 10 per cent. Many of these cuts are in fact welcome as their central banks are tightening monetary policy rather than easing it.

Global growth is thus still likely to approach 4 per cent in both 2008 and 2009 in spite of the sharp slowdown in its largest single economy. The emerging market economies, which now account for half of world output calculated at purchasing power parity exchange rates by the International Monetary Fund, are still expanding at 6-7 per cent. Even the nearest neighbours of the US – Canada and Mexico – are nowhere near recession and have altered their policies much less forcefully. In spite of the international transmission of substantial financial as well as real economic shocks from the US, the traditional relationship where “the world catches cold when the US sneezes” no longer holds.

The second striking feature is the reverse coupling of the global economy. Over the past two quarters, the US has recorded positive growth at an annual rate of 0.8 per cent (in spite of the pronouncements of many observers that recession had already set in). Its “net exports of goods and services”, the gross domestic product equivalent of the current account balance, have strengthened at an annual rate of almost 1 per cent of GDP during that period. Hence the totality of recent US expansion has been provided by the strengthening of its trade balance. Domestic demand has been falling but the US has been saved from recession by the rest of the world.

The improved US trade performance of the past two years is due partly to the substantial, if lagged, restoration of the country’s price competitiveness as the dollar declined by a trade-weighted average of 25-30 per cent since early 2002, reversing most of its excessive run-up during the previous seven years that produced unsustainable current account deficits exceeding 6 per cent of GDP. Equally important, however, is the continued robust growth of the world economy. Every percentage point by which the rest of the world expands domestic demand faster than internal growth in the US produces gains of about $50bn (€32bn, £25bn) for the US external balance. Weighted by US exports, foreign growth exceeded US growth by about 2 percentage points in 2007 and will do so by an average of about 1.5 points this year and next as decoupling persists. Taken together, these currency and comparative growth factors have already improved the real US trade balance, and hence GDP, by almost $150bn since 2006, with gains of another $150bn or so likely through 2009. (The nominal US trade and current account deficits will not improve as much because of the sharp rise in the price of oil imports.)

The Organisation for Economic Co-operation and Development’s new Economic Outlook projects that more than 80 per cent of all US growth in 2008-09 will derive from continued strengthening of its external position. Exports have been climbing at an annual rate of about 8 per cent, at least six times as fast as imports. Unless domestic demand takes an unexpected further fall in the quarters ahead, reverse coupling of the global economy will thus have prevented the US recession that was so widely predicted and feared. Presidential candidates and members of Congress who believe that the US is losing from globalisation should take note of this export-led growth and its creation of excellent new jobs, and recognise the folly of backing away from international trade at a time when it is providing critical gains for their country.

These international macroeconomic developments also provide another telling indication of the shifts in global economic power. As noted, the emerging market economies make up about half the world economy, so their growth of 6-7 per cent assures reasonably strong world output increases even if there were no expansion at all in the rich countries. China alone accounts for 10 per cent of the global total, so its annual expansion of 10 per cent generates a full percentage point of world growth all by itself. The steadily rising diversification of global economic leadership is paying huge dividends to all its participants, most dramatically during this episode to the US as export-led growth saves it from at least the worst ravages of its housing bubble and associated policy errors.

The writer is director of the Peterson Institute for International Economics