Confidence in the global recovery is at a crossroads and the
uncertainty about the road ahead has clearly fed through to financial markets
in recent weeks.
Much of the blame for the recent downturn in sentiment lies
at the euro zone’s door where renewed risks of recession, deflation and the
deepening of a supposedly cured debt crisis loom large.
But it will take a global effort to stop the rot. Five
simple steps can easily mend the process of recovery. But it will take
determination, flair and resolute action to put them into play.
1. The euro zone must adopt full-blown QE. Another shot of
monetary stimulus is urgently needed. The European Central Bank’s recent
decision to buy asset backed securities (ABS) in the hope of sparking a bank
lending spree to jump-start faster recovery looks far too tame. ECB President
Mario Draghi has hinted the ABS buying programme could be stretched to 1
trillion euros, but an asset purchase programme at least three to four times
that size is needed to deliver a turnaround like that seen in the US and UK
economies. Unfortunately, the German government and the Bundesbank still stand
in the way. For them, full-blown QE remains a domestic political taboo, but
Germany must embrace its responsibilities as a world economic leader –
prioritising its commitment to a stronger, united Europe, instead of being
side-tracked by myopic domestic issues. The survival of the single currency is
at stake.
2. The euro zone should suspend the Fiscal Stability Pact.
Vigorous Keynesian fiscal reflation is the second pre-requisite for recovery.
Inadequate ECB monetary easing efforts so far have been badly blunted by
intense political pressure on euro zone governments to balance their budgets
and cut debt. Austerity cuts have deprived the recovery of vital stimulus and
left unemployment at record highs around the region. A number of countries,
including France and Italy, have ditched debt reduction and made stronger
growth their top priority. This leaves Germany increasingly isolated on its
prescription for an economic revival based on a balanced budget and no new debt
issuance. The Fiscal Stability Pact should only resume when the euro zone is
back to full employment and sustainable growth. That could be many years away.
3. A weaker euro is crucial for an export led recovery. The
euro’s 10 per cent fall since May has given euro zone exporters a much needed
competitive boost, but the windfall would have been much better if policymakers
had actively encouraged the euro to weaken even more. The euro probably needs
to drop a further 10-15 per cent before stronger export demand begins to have a
more positive impact on euro zone growth prospects. A weaker euro would also
raise import costs and act as a further foil against deflation.
4. The US and the UK must hold their fire on monetary
tightening. There is no need to rush into raising interest rates or to unwind
their QE asset stockpiles, particularly while the outlook for global recovery
looks uncertain and low inflation continues to loom over the US and UK. The US
Federal Reserve and the Bank of England would both be better advised to keep
their policy powder dry should global economic conditions take a turn for the
worse.
5. China must maintain a bias towards more easing. With
China’s growth rate slowing to 7.3 per cent in the third quarter, the economy
risks missing its official annual GDP target – 7.5 per cent for 2014 - for the
first time in 15 years. China’s authorities could definitely lend a hand with
easier monetary policy to boost domestic demand, increasing the economy’s
appetite for imported goods and services at the same time. It would be a
positive step in the government’s quest to reshape the economy towards more
domestic consumption. But China would also win greater plaudits for making a
stronger contribution to global recovery.
This is a moment of opportunity for global policy makers to
turn things around. If they fail and the world economy and financial markets
dive, they only have themselves to blame.
Reprinted courtesy of South China Morning Post 27 October 2014
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