The 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 the 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 in 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 slow-growth world.
Consider fiscal policy. In developed markets, collective fiscal stimulus amounted to 3.9 per cent 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. The US' public debt will soar from 62 per cent of GDP in 2007 to well beyond 100 per cent by 2014. The UK, with a public debt/GDP ratio of just 47 per cent in 2007, is also headed for 100 per cent, followed closely by Germany and France. Japan will swamp everyone with a rate well over 200 per cent.
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 points 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 months away.
Peter G. Hall is the vice-president and chief economist of Export Development Canada