Raghuram Rajan writes: As 2015 ended, the world boasted few areas of robust growth. At a time when both developed and emerging-market countries need rapid growth to maintain domestic stability, this is a dangerous situation.
So how does one offset weak demand? In theory, low interest rates should boost investment and create jobs. In practice, if the debt overhang means continuing weak consumer demand, the real return on new investment may collapse.
Another tempting way to stimulate demand is to increase government infrastructure spending. In developed countries, however, most of the obvious investments have already been made. And while everyone can see the need to repair or replace existing infrastructure (bridges in the United States are a good example), badly allocated spending would heighten public anxiety about the prospect of tax hikes, possibly increase household savings, and reduce corporate investment.
Structural reasons for slow growth suggest the need for structural reforms: measures that would increase growth potential by spurring greater competition, participation, and innovation. But structural reforms run up against vested interests. As Jean-Claude Juncker, then Luxembourg’s prime minister, said at the height of the euro crisis, “We all know what to do; we just don’t know how to get re-elected after we’ve done it!”
If growth is so hard to achieve in developed countries, why not settle for lower growth? After all, per capita income already is high.
One reason to press on is to fulfill past commitments. In the 1960s, industrial economies made enormous promises of social security to the wider public. Technological change and globalization mean fewer good middle-class jobs for a certain level of growth, more growth is needed to keep inequality from widening.
Finally, there is the fear of deflation, the canonical example being Japan, where policymakers supposedly allowed a vicious cycle of falling prices, depressed demand, and stagnant growth to take hold.
In fact, this conventional wisdom may be mistaken. After Japan’s asset bubble burst in the early 1990s, the authorities prolonged the slowdown by not cleaning up the banking system or restructuring over-indebted corporations. But once Japan took decisive action in the late 1990s and early 2000s, per capita growth was comparable to that in other industrial countries. Moreover, the unemployment rate averaged 4.5% from 2000 to 2014, compared with 6.4% in the US and 9.4% in the eurozone.
If debt is excessive, a targeted restructuring is better than inflating it away across the board.
The specter of deflation haunts governments and central bankers. Hence the dilemma in industrial economies: how to reconcile the political imperative for growth with the reality that stimulus measures have proved ineffective, debt write-offs are politically unacceptable, and structural reforms frontload too much pain for governments to adopt them easily.
Developed countries have just one other channel for growth: boosting exports by depreciating the exchange rate through aggressive monetary policy. Ideally, emerging-market countries, funded by the developed economies, would absorb these exports while investing for their future, thereby bolstering global aggregate demand. But these countries’ lesson from the emerging-market crises of the 1990s was that reliance on foreign capital to fund the imports needed for investment is dangerous. I
By 2005, Ben Bernanke, then a governor at the Federal Reserve, coined the term “global savings glut” to describe the external surpluses, especially in emerging markets, that were finding their way into the US. Bernanke pointed to their adverse consequences, notably the misallocation of resources that led to the US housing bubble.
In other words, before the 2008 global financial crisis, emerging and developed countries were locked in a dangerous symbiosis of capital flows and demand that reversed the equally dangerous pattern set before the emerging-market crises of the late 1990s.
In an ideal world, the political imperative for growth would not outstrip an economy’s potential. In the real world, where social-security commitments, over-indebtedness, and poverty will not disappear, we need ways to achieve sustainable growth.
The bottom line is that multilateral institutions like the International Monetary Fund should exercise their responsibility for maintaining the stability of the global system by analyzing and passing careful judgment on each unconventional monetary policy (including sustained exchange-rate intervention). The current non-system is pushing the world toward competitive monetary easing, to no one’s ultimate benefit. Developing a consensus for free trade and responsible global citizenship – and thus resisting parochial pressures – would set the stage for the sustainable growth the world desperately needs.
