Global Monetarism Strikes Back

Matías Vernengo

Olivier Blanchard, the chief economist at the International Monetary Fund (IMF) announced in a triumphalist tone that “earlier fears of a double-dip recession—which we did not share—have not materialized” and defended the need for “fiscal consolidation that is neither too fast, which could kill growth, nor too slow, which would kill credibility.” For Blanchard fiscal expansion has done its job, since “private demand has, for the most part, taken the baton.”  The risks are associated to the higher prices of commodities and inflation.  The Bank of International Settlements (BIS) has added to the IMF’s view that inflation is the main risk on an otherwise recovering world economy.  In their recent Annual Report they argue that: “spread of inflation dangers from major emerging market economies to the advanced economies bolsters the conclusion that policy rates should rise globally.”  That is, add monetary contraction to the policy mix.

However, it is far from clear that private demand is sufficiently strong to maintain the recovery by itself, or that slacking capacity, beyond commodity prices, imply that inflation has become the major risk to the global economy.  The two-speed recovery – sluggish in developed countries and fast in developing countries – remains a fragile one, and the possibilities of rates of growth that are insufficient to bring back the prosperity of the boom years, and increase employment and living standards around the globe are still strong.

The process of financial deleveraging continues to maintain the expansion of demand checked in developed countries, and the higher levels of liquidity after the crisis have not been translated into increasing credit for productive activities.  Levels of unemployment remain significantly higher than before the Great Recession, and the evolution of real wages, which have stagnated in developed countries, indicates that private demand will not be able to produce a self-sustaining recovery.  Sum et al (2011) refer to this as “the jobless wageless recovery.”

In spite of the poor recovery, it seems that Obama would accept significant spending reductions, and cuts to Medicare, Medicaid and even Social Security as part of a debt-ceiling bargain with House Republicans.  Also, Bernanke has already announced that Quantitative Easing is off the table.  In Europe, the European Central Bank (ECB), which has already started hiking interest rates, and the IMF will continue to impose contractionary monetary and fiscal policies, in particular, in the troubled European periphery.

In developing countries a shift towards a process of growth that is more dependent on the expansion of domestic markets has been possible as a result of counter-cyclical measures, the expansion of commodity prices and the expansion of real wages.  In that sense, while the recovery in the advanced economies has been wageless the recovery in the developing countries has been, to some extent, wage-led.  The International Labour Office has shown that real wages have expanded in developing countries in their Global Wage Report (2010-2011).  While developing countries seem to be able to rely more on private demand, and have been spared from the worst effects of the financial crisis, as a result of having less developed financial systems and of having experienced major financial crises in the late 1990s and early 2000s, that does not imply that there are no risks for the continuity of their recovery.

In particular, the increase in financial inflows and the persistence of carry trade speculation, with the consequent pressures for exchange rate appreciation, in conjunction with higher real wages, may imply that external competitiveness could be eroded.  The financialization of commodity markets and the lack of major reform in international financial markets suggest that there are considerable risks for sustaining the rates of economic expansion in developing countries (UNCTAD, 2011).  That is why reform of financial markets is still essential for self-sustained recovery in the periphery.

In this sense, the main risks associated with the current recovery are the incapacity of private demand to create the conditions for a self-sustaining resurgence of demand and the early withdrawal of fiscal and monetary stimulus, in particular in developed countries that, together with the ongoing financial deleveraging process, imply that growth will remain subdued.  The return of fiscal austerity and a more contractionary monetary stance, what we may call Global Monetarism, has reasserted itself before the economy got back on its own feet.  The return of the master (Keynes) proved to be too short-lived, and that is the real danger faced by the global economy.