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Symposium 2014

Proposal - Measure and act!

The Challenge

Recent debt, currency, or banking crises have proven how difficult it is to forecast such events, let alone to prevent them. For example, the fiscal surveillance mechanism in the Euro Area was unabl ...

Recent debt, currency, or banking crises have proven how difficult it is to forecast such events, let alone to prevent them. For example, the fiscal surveillance mechanism in the Euro Area was unable to prevent the Euro debt crisis, still faced by some EU countries. Consequently, the EU and the G-20 have called for strengthening macroeconomic surveillance by means of closely monitoring a broad set of potential imbalance indicators. However, many issues with regard to macroeconomic surveillance are still hotly debated among economists and policymakers. Analyzing the potential of macroeconomic surveillance and developing forward-looking proposals for its improvement, could certainly contribute to a more stable economic system in the future.

 

  1. Is there a need for macro-economic surveillance? Yes. Macroeconomic surveillance is a critical requirement for addressing many of the overarching, current economic challenges. Yet mere surveillance is ineffective, unless followed up with swift intervention for implementing and executing the required policy changes. For example, macroeconomic surveillance can give us valuable information about the significant debt expansion in the public as well as private sectors. It can highlight the sustained trade imbalances between trade surplus countries like China & Germany, and those running trade deficits, like USA and peripheral European countries. Such macroeconomic surveillance will have served its purpose only if it be accompanied by the necessary implementation measures that promote growth and avoid what Larry Summers re-coined as “secular stagnation”.
  2. Should we address the problem? Yes. Just a few years in the wake of the most significant global economic crisis since the 1930s, governments have returned to their pre-crisis behavior. Debt continues to grow faster than income in most countries; trade-imbalances are at the same, in some cases even higher, levels. The initial thrust towards global cooperation in 2008 has been forgotten. If we do not address the issue fast we run the risk of increased tensions, protectionism and defaults.
  3. Is it possible to address the problem? Yes. Step 1: monitor and limit credit growth: credit is nothing else than foregone future consumption. Therefore the growth of debt in an economy should be monitored and limited. Research shows that a sustainable level for government debt is in the range of 50-60% of GDP. ( See for example: OECD: »Fiscal Consolidation: How much, how fast and by what means«, April 2012, http://www.oecd.org/tax/public-finance/50106656.pdf) Debt levels of 90% and above have proven to be detrimental for growth irrespective of whether it was public or private debt (Stephen G. Cecchetti, et al, The real effects of debt, BIS Working Paper No. 352, September 2011). It would be best therefore to limit the growth of debt to a maximum threshold of 60% per sector: government, non-financial corporations and private households. Two dimensions relating to debt development should be measured by sector: absolute debt levels and speed of debt build-up. Once debt grows faster than GDP the monitoring (i.e. surveillance) alert should be activated. Above a certain threshold - say 40% - the first brakes would have to be applied, e.g. in the form of higher equity requirements. The closer debt levels get to the 60% threshold, the stricter the counter measures should become. Changing our monetary system towards sovereign money would clearly facilitate such measures, as it would put an end to the unhindered debt creation by commercial banks in today’s fiat money system. Step 2: Although I believe that restrictive measures on debt would be the easiest and most efficient way to prevent economic imbalances including persistent trade deficits, one could argue for an international clearing mechanism for trade surpluses and deficits, as proposed by Keynes during the negotiations in Bretton Woods.  Specifically he asked for a Clearing Union. It seems to be possible to implement such a clearing union in today's world. (The discussion of the applicability by Lilia Costabile, Current Global Imbalances and the Keynes Plan, Working Paper 156, University of Massachusetts, Amherst, December 2007, http://scholarworks.umass.edu/cgi/viewcontent.cgi?article=1127&context=peri_workingpapers). The benefit would be that it indirectly limits (through the effect of market, competitive and macroeconomic forces) the ability of a country to live beyond its own means or to follow a mercantilist policy.
  4. Who should supervise? The international clearing house could become a global central bank monitoring, and also influencing, the economic policies of member countries. The BIS could evolve into such an organization. A precondition is a broad support by many governments and central banks. Voting rights should be in relation to size and development status of an economy ensuring sufficient participation and influence for developing economies. The basic principles have to be agreed upon in the beginning to ensure that once the monitoring gets active there is no possibility to tweak the rules under pressure from a few countries.
  5. Will the problem be addressed? I do not believe in the ability of a single, international supervising body, to have the means of not only monitoring but also acting on imbalances. Politicians will always look for the direct (and short-term) benefits to their electorate. Principles, as good as they might seem in theory, will not pass the test in practice. The Maastricht treaty on the Euro is a case in point. Instead I would advocate two mechanisms:  a) fast development and implementation of a standardized insolvency process for governments and b) implementation of orderly process of dealing with insolvent banks focusing on creditor involvement. If implemented this would lead to more caution on the side of financial markets, being worried about the credibility of debtors and therefore demanding a higher risk premium early on. Just last week, a group of about 400 banks, investors and debt issuers agreed on a new framework for dealing with sovereign debt defaults – triggered mainly by the Argentina default about a month ago. (“New framework for sovereign defaults”, Financial Times, August 6, 2014) Such a signaling effect might be more effective than a non-enforceable international treaty. A clearing house would be even more effective but I doubt that the world is ready to go down this path yet.

The author would like to thank Mr. Shirish Pandit for his support in preparing this comment.

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