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Thursday, June 18, 2009

A Lasting Recovery?

Olivier Blanchard argues that global imbalances must be resolved in order to put the world economy on a sustainable path to recovery:

What is needed for a lasting recovery, by Olivier Blanchard, Commentary, Financial Times: In 2007, worried about the growing size of current account imbalances, the IMF organised multilateral consultations to see what should be done about it. There was wide agreement that the solution was conceptually straightforward. To caricature: get US consumers to spend less. Get Chinese consumers to spend more. This would be good for the US, good for China, and good for the world. ...

It was an impressive piece of global macroeconomic planning. But, at least until the crisis, not much happened. ... And, since the beginning of the crisis, dealing with global imbalances has gone down the priority list. ... As the crisis evolves, however,... the issue of global imbalances is likely to return to the fore. Again, a central role will have to be played by the US and by China.

Half of the adjustment ... is coming into play: US consumers are, at last, cutting their spending. ... And ... they have learnt a more general lesson. The world is more risky than they thought. ...

The main unknown is about the other half of the adjustment. In response to the crisis, China has embarked on a major fiscal expansion, with a focus on investment rather than on consumption. This was the right policy given the need to increase spending quickly... The question is whether, as time passes, China will allow an increase in consumption. If it does, the 2007 master plan may come into being. ... The world recovery can proceed and we can emerge with a more balanced world economy.

Will this scenario naturally play out? Maybe, maybe not. China has announced ambitious healthcare reform, which goes in the right direction. But the export-led model that China has so successfully followed will not be abandoned overnight. And ... the crisis may have convinced many countries to accumulate even more reserves, thus running even larger current account surpluses. These countries will not be eager to appreciate against the dollar, and so allow for larger US net exports.

What if there is no rebalancing? Without ... higher net exports, the US recovery may weaken once the fiscal stimulus is phased out. In normal times, monetary policy could help, by lowering interest rates...; these are not normal times and rates can fall no further. Thus, there will be heavy pressure on the US government to maintain a strong fiscal stimulus for as long as private demand is weak... While strong fiscal stimulus was and still is needed to fight the crisis, it cannot go on forever; at some stage, debt dynamics become unsustainable...

Sustained recovery requires decreased domestic US spending and increased domestic spending in China and much of the rest of the world, together with adjustments in exchange rates. ...

    Posted by on Thursday, June 18, 2009 at 05:08 PM in China, Economics, International Finance, International Trade, Saving | Permalink  TrackBack (0)  Comments (10)

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