Five steps to fix the world

In this week’s Newsweek there was a section in which 5 Nobel Economists gave their interpretation of the World’s recession. Michael Spence, a 2001 Nobel laureate in economics, looked at the essential ingredients of future global economic policy- he came up with 5 steps:

1. The US and Europe must restore fiscal balance. In Europe it means the recapitalising of countries like Portugal, Ireland, Greece, Spain (PIGS). It does suggest that stronger countries like Germany will have a lot of responsibility. In the US the requirement is to restore fiscal balance without affecting the recovery.

2. Intervention in the US economy especially in the housing where faltering performance could produce another downturn. But this must be far more precisely targeted than QE2. America’s reluctance to target areas of fragility leaves the impression externally that QE2’s real goal was to weaken the US$ by injecting more cash into the market.

3. Advanced and emerging economies that are running surpluses must get rid of them. For instance China needs to shift income to the household sector, where the savings rate is high but still lower than the corporate rate. The economy can then use houshold savings to finance corporate and government investment, rather than the US government.

4. The global economy will be out of balance as long as the US runs larges current-account deficits. With the post-crisis resetting of domestic consumption and savings, US aggregate demand will remain depressed. In the longer run, that gap needs to be filled by higher foreign demand and increased export potential.

5. Major holders of reserves must agree to deploy them so as to maintain global financial stability and prevent excessively volatile exchange rate and capital movements. With concerns in the US and Europe major reserve holders in Asia and the Gulf need to become a stabilising counterweight.

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