The struggle for recovery

Challenges 1.Getting out of the present crisis 2.Making sure it never happens again 3.Ensuring sustainable, socially inclusive growth Same remedies won’t work for all. Different policies called for each.

Diagnosis and solutions (1) Short-term challenge: reviving demand – There is reasonably convincing evidence that fiscal stimulus helps raise incomes and employment – And very little evidence that fiscal austerity does same The “confidence fairy” – On balance, strong presumption that expansionary fiscal policy would help revive demand – The case for fiscal stimulus is much stronger in countries with trade surpluses (China, Germany) or which face little bond-market pressure (U.S., U.K.).

Fiscal stimulus and employment, by states Source: Feyrer and Sacerdote, 2011

How changes in government spending helped in 2009 (and now hurt) Quarterly change at seasonally adjusted annual rate. Source:

The fiscal drag Source:

Diagnosis and solutions (2) Tougher regulation of domestic finance – Not rocket science: prevailing regulations prevented systemic financial crises for more than five decades since World War II Rules that penalize too much leverage, prevent regulatory arbitrage, and break-up banks that pose systemic risk

Diagnosis and solutions (3) Putting brakes on financial globalization – No global counterpart of domestic institutions of regulation and stabilization Lender of last resort, bankruptcy and orderly workouts, fiscal stabilizers, lack of common legal jurisdiction – Special problems of developing nations Capital inflows, currency appreciation, and “Dutch disease” – Role for controls on cross-border capital flows to protect integrity of national regulations Prevention of regulatory arbitrage

Diagnosis and solutions (4) Generating shared growth in the new world economy – The new global division of labor has generated excess supplies of labor, capital, and production relative to demand – And it squeezes the middle class in industrial economies Key components of a growth program – public investment in infrastructure – debt relief for households – tax progressivity – getting high-saving economies (esp. China) to spend more (“global rebalancing”) – … – deeper institutional innovation (in finance, industrial policy, education…)

The Eurozone: a special case Current strategy consists of the application of austerity policies as solution to debt problems in Greece, Portugal, Spain, Italy, Ireland. – Combined with private-sector partial debt write-downs in Greece Results in debt-recession cycle Either Eurozone turns into true fiscal/political union, with significant transfers from North to South – U.S. example Or debt defaults and EZ exits become politically inevitable

European obsession with “structural reforms” What Europe means by structural reform – labor market flexibility (i.e., making it easier to lay off workers; l – liberalization of product and service markets (i.e., freeing up entry and price setting) – privatization (i.e., selling off state assets) Unlikely to generate private investment in midst of recession And likely to exacerbate unemployment and therefore demand shortfall Even these reforms made sense in medium- and long- run, may backfire in short-run

Broader point about structural reform versus Keynesian demand management Ambitious structural programs (whether of the previous type or others) unlikely to mobilize private investment and initiative in the midst of demand slump Keynesian demand policies are an important bridge to medium-term policies Without which, deeper seated reforms remain ineffective or backfire

Questions Domestic: do we have the political coalitions that can support these policies? International: do we have the global cooperation/leadership needed?

Recovery from Great Depression Source: