Voices of giants: Directions from international policymakers
July 20, 2012 00:00 By Piyasak Manason
It is not every day that a humble economist has the opportunity to listen to heavyweight policymakers and advisors.
So when the Finance Ministry’s Fiscal Policy Research Institute invited me to participate in the Thailand ADB-IMF Conference “Towards a More Stable Global Economic System”, with speakers including International Monetary Fund chief Christine Lagarde and her Asian Development Bank counterpart Haruhiko Kuroda, I was honoured and grabbed the opportunity.
And I was not disappointed. Although the seminar last week was a forum for exchanging views rather than a deal-breaking conference, it nevertheless revealed what global and regional policymakers/advisors have on their minds and therefore acted as a guide to the future.
The topics discussed at the conference can be summarised under three headings:
First, the global economic outlook and risk associated with it. Second, the new global economic and financial landscape. And third, the policy response to those discussed risks.
_ Economic outlook and risk: the forum concluded that global growth in 2012 will decelerate from last year, due mainly to the lingering effects of the 2008-‘09 financial crisis. The main downside risk to growth, the forum concluded, came from three areas.
The first is the debt-ceiling situation in the United States. The programme of tax cuts and spending, equal to about 5 per cent of total GDP and initiated since the onset of the crisis, will expire this December. This “fiscal cliff” could potentially be a major drag on the economy, since it is huge in size, its date is set and there is no immediate resolution.
The second risk to global growth centres on the euro zone’s debt woes. Even though European policymakers have done all they can – including injection of liquidity, increased commitment to a greater union, and erecting a firewall against spillover – one thing they cannot control is financial market sentiment and its potential to create a negative-feedback loop for the economy in times of panic.
The third and final risk surrounds the oil price. Despite a recent fall, the oil price is on the way up again. Since the beginning of July, the price of Brent has risen and stuck at around US$100 per barrel. This is due to increasing global demand, especially from Japan and China, dropping supply because of Iran sanctions, and speculation as a result of global central banks’ liquidity injection. If the price stays high, it will undoubtedly affect global industrial production and subsequently the world economy.
_ New global economic and financial landscape: The trend of globalisation and liberalisation as well as the impact of the world financial crisis brought agreement we had entered a new terrain. The new landscape is governed by three main forces. First, the globe is entering a “new normal”, where the source of growth is shifting from the mature economies to the emerging ones. This is due to a shift in competitiveness between the two groups, which has led to higher unemployment in the developed economies.
The second force is the rising interconnectivity of the world economy, both in the real and financial sectors. This buzzword describes increases in the interrelationship and magnitude of global trade as well as in capital and information movement across nations. The third force is greater volatility, especially in the financial sector. This is due to interconnectivity along with the increasing use of leverage to finance capital.
These three forces have propelled us into a rapid boom-and-bust cycle. This “new normal” means that during a “risk-on” period, capital is likely to flow into emerging market’s assets, due to their greater economic potential higher expected returns. This will be reversed during the “risk-off” period. The interconnectivity between economies and markets, as well as the popular use of leverage, both in traditional and in sophisticated financial instruments, amplifies the volatility of asset prices.
The evidence is visible. One forum member estimated that gross leverage in the global financial sector accounts for 16 times global GDP; hence the recent deleveraging trend in the rich world has led to substantial global slowdown. Another member estimated that, with the gigantic amount of liquidity and leverage in developed economies, a small adjustment in the balance sheet of the rich world’s financial institutions (say, 5 per cent of total assets) would signal the flow of about US$2 trillion in capital to the developing world. This fine balance is the reason behind the seesawing of the latter’s currencies.
_ Response to risks: The third and final topic discussed at the conference was the policy response to the risks and changes in the global landscape.
Three recommendations were given. The first was to increase coordination between policymakers at every level – global, regional and national, both in terms of economic surveillance and as a financial safety net. An example that drew wide praise was the Chiang Mai Initiative, the US$240-billion fund built by the Asean nations and China, South Korea and Japan, designed to manage liquidity problems in times of crisis.
The second recommendation was for a paradigm change in our thinking on policy. Due to the interconnectivity of economies and markets, policymakers need to carefully analyse the impact of their actions on every stakeholder. Hence, careful and heedful design of policy is crucial. For example, in the case of managing capital flow, the choice regarding macroeconomic policy at the fiscal and monetary level, macro-prudential policy that targets different sectors, and short-term measures like capital control, needs to be carefully considered to ensure effectiveness and minimal side-effects.
The last recommendation for policymakers dealing with the “new normal” was to strike a balance between short-term and long-term goals. In the short term, measures to counter the boom-and-bust cycle are important. But these should be accompanied by actions encouraging long-term sustainability of economic growth. A good example of policy imbalance would be too-tight austerity imposed by Germany on peripheral euro-zone countries: it may bring fiscal discipline in the long run but it will also lead to severe economic contraction in the short run.
The conclusion was that policymakers must respond to the change in the economic landscape by changing the way they formulate policy.
It is now up to us, global businesses and investors, to bear this in mind when planning our long-term survival strategy in this volatile new environment.
Piyasak manason is vice president for research and planning at Kiatnakin Bank.