The global financial crisis brought widespread agreement on dramatic policy measures. Today, there is considerable disagreement about policy settings.
As worries grow about the nascent recovery faltering, policy tightening has commenced, with much more to come.
We are not alone in worrying that the recovery is not yet self sustaining, and that a number of countries may need more, rather than less, stimulus. What is most clear is that the risk of a policy mistake is now high.
This is a complex environment, which is sufficiently unusual that the lessons of the past may not apply. The global economy is a long way from being normal. The developed market banking system has not yet been adequately recapitalised. The imbalances we worried about pre-crisis are still there.
For example, China is spending too little and the US is still spending too much. Chinese growth has been an important source of stability for the global economy but expectations that policy makers will continue to get it right may be tested as they attempt to engineer multiple outcomes – a switch from export led to consumption led growth; reducing reliance on an undervalued exchange rate which has supported strong export led growth but resulted in rising asset prices and inflation risk; and controlling the residential property market bubble.
While risks of a hard landing in China have risen, developed market (DM) growth will remain hampered by excessive debt levels for an unknown number of years.
The risk of a Japanese style slump is significant, particularly as the risk of withdrawing stimulus too soon is greater than withdrawing too late.
The US preoccupation with reducing the budget deficit risks repeating the mistake of 1937, when policy was tightened prematurely. While we recognise the dangers of withdrawing stimulus, the US public sector debt is close to 100 per cent of GDP (IMF estimate) so there needs at least to be a plan for lower spending in due course.
In Euroland where public attention is focused, there are warnings that the cutbacks are too great and that the authorities are trying to buy time rather than provide a full solution. The core is strong while parts of the periphery are in deep trouble. Meaningful action will not occur without a new crisis. In the interim, they will duck and weave as much as possible. Tension is rising and the tolerance of the public in both the core and the periphery is wearing very thin.
A difficult but pivotal question is what policy makers should now be doing.
Structural reform is required.
For example, reforms are also needed to address the long term fiscal implications of population aging. However, while such reforms will assist at the margin, it is getting the monetary and fiscal policy setting right that will have the greatest impact on getting the global economy out of the woods.
And this won’t be easy to achieve in today’s environment where the breadth of uncertainty is currently well beyond what we typically face.
Dr Susan Gosling is head of investment at MLC.
