Economies in a Policy Squeeze
PETER G. HALL
and Chief Economist
recent recession was shock enough, but it was at least rivalled for
effect by the public policy response that followed. Overnight, Western
economic policy turned on a dime. Crisis led to a swift, significant and
highly synchronized global response, with governments everywhere
pledging to cut rates, spend, and do ‘whatever it takes’. Suddenly,
the policy world seemed a very different place.
Did it work? The results were impressive. Banks and insurers were
rescued. Spending measures saved hard-hit industries like auto
manufacturing and construction, which have survived and in some cases,
thrived in the aftermath. Lower interest rates cushioned the blow that
recession dealt to consumers and businesses alike. And by all
appearances, GDP growth itself was kicked up, especially in the
six-month period that began in October, 2009.
So far, so good. But growth began to stall in the spring, causing
widespread doubt about the aggressive policies’ success at achieving
their desired end: a return to sustainable growth. Would another round
help? It might, if there was the collective capacity. Unfortunately,
‘whatever it takes’ took whatever they had. Policy-wise, most of the
large economies in the world are more or less tapped out, with little
short-run flexibility – hardly a comfortable predicament for a
Consider fiscal policy. In developed markets, collective fiscal stimulus
amounted to 3.9% of OECD-wide GDP. By any standard, this was a giant
effort, and as always, giant efforts have giant price tags. Stimulus and
the effects of recession have together caused public deficits to
balloon, giving rise to an alarming surge in public debt. US public debt
will soar from 62% of GDP in 2007 to well beyond 100% by 2014. The UK,
with a public debt/GDP ratio of just 47% in 2007, is also headed for
100%, followed closely by Germany and France. Japan will swamp everyone
with a rate well over 200%.
The options are few. Immediate austerity could tip off a double-dip
recession. Doing nothing or further augmenting debt-financed stimulus
would put sovereign debt ratings at risk, worsening the fiscal outlook.
The actual responses? Thus far, they run the gamut, with some cutting
drastically, others in policy limbo, and yet others adding further
stimulus. A stark contrast to the initial coordinated stance.
In the monetary policy arena, response to the crisis was immediate. The
US Federal Reserve slashed rates by 500 basis point between September
2007 and late 2008 and the target rate is now as low as it gets. Similar
moves occurred in most other developed markets. Consequently, these
monetary authorities have little if any interest rate room to add
further support to the tentative world economy.
Which is why monetary authorities have resorted to ‘quantitative
easing’ (QE), the creation of new paper money to buy financial assets,
injecting money into the system and lowering existing borrowing costs.
Round two has just begun, but many doubt its effectiveness. Lending
remains tight, and the private sector is hesitant to borrow, leaving
many crossing their fingers and hoping for the best.
The bottom line? Where governments could have a big impact, they have
little capacity, and where they have capacity, they stand to have little
impact – a delicate dilemma, given renewed slowing. Quelling today’s
policy concerns requires a lasting recovery, but true recovery is still
views expressed here are those of the author, and not necessarily of
Export Development Canada.