After the Great Moderation

A display of decisive leadership will be needed to solve the economic crisis.

In Paris last weekend (18-19 February) representatives of the 20 or so major economies in the world agreed on only unconvincing steps towards stabilising the global economy. Once again participants dashed the hopes of naive optimists that the G20 club would swiftly be laying the foundations for a new structure of global economic co-operation. 

Setting the tone, even before the G20 finance ministers and central bankers held their first session, Ben Bernanke, the chairman of the Federal Reserve Board, the central bank of the United States, poured petrol on the glowing coals of Sino-American relations.

In a speech on Friday (18 February) Bernanke reprised his familiar complaint that the world economy is in trouble because of China’s “saving glut”. Perhaps Bernanke should turn for guidance to the memoirs of his former comrade-in-arms, ex-US treasury secretary Hank Paulson.

There, Paulson bravely gives Bernanke’s “savings glut” hypothesis a resounding raspberry. The biggest factor behind Chinese reserve accumulation, he writes, was “the lack of savings by Americans, which translated into massive levels of imports and over-reliance on foreign capital flows”.

There are many reasons why the G20 is not living up to the expectations of gullible commentators who swallowed whole the propaganda surrounding the first G20 summit in Washington, DC, in November 2008. Now that the unifying pressures of the worst of the financial crisis have eased, powerful economic and political tensions are tearing at the seams of the threadbare G20 fabric.

It is easy to forget that the 20 years leading up to the beginning of the financial crisis in August 2007 were a golden era for global prosperity. Economists even give it a name, the “Great Moderation”, primarily because it was a period that saw the taming of the inflationary spiral that had blighted the 1960s and 1970s.

Unconvincingly, some academic economists and central bankers even claim that it was the theories and policies that they formulated or implemented that accounted for this “success”. The successes, which actually contributed to equally dangerous asset-price bubbles, owed far less to the setting of appropriate inflation targets and the manipulation of expectations than these claims suggest.

Political stability

The economic prosperity of the Great Moderation contributed to political stability. There were, of course, upheavals. The Soviet Union disintegrated, but largely peacefully. First Mexico in 1994-95 and then several Asian developing countries and Russia in 1997-98 experienced debt crises. But the prosperity and stability of the transatlantic economies that accompanied the Great Moderation helped to contain these crises.

In the Asian and Russian cases, incidentally, the then imminent launch of the European single currency was another stabilising influence. The Great Moderation’s steady growth also helped China’s new economic policies launch the astounding transformation of the Middle Kingdom.

Today, however, with the Great Moderation over and the world facing inflationary pressures, signs of stress and confrontation abound, most obviously of course in North Africa and the Middle East. There, historically poor economic outcomes and, now, rising food-price inflation are contributing to mushrooming political instability.

Indeed, if food-price inflation is an ingredient in that region’s political instability, then perhaps the nation state that has most to fear is not a Middle Eastern neighbour of Egypt but the Middle Kingdom itself. “Egypt” writes David Pilling, the Financial Times’s perceptive Asia editor, “raises some awkward questions for Beijing.”

Remarkably, given the sluggish growth in the advanced half of the global economy, it is not just commodity-price inflation that is a source of global economic and political stress. Trade and currency tensions are increasing globally. As Bernanke’s comments remind us, global imbalances – the US current account deficits and the offsetting surpluses and accumulating reserves in export-focused economies, including China, Japan and Germany – are widening again. Stability is a long way off.

A two- or three-speed Europe?

The European Union is experiencing mounting political and economic strains too. This month’s meeting of EU leaders had hardly finished before Janusz Lewandowski, the European commissioner for financial programming and budget, was warning that economic governance reforms driven by Germany and France risked creating “a two-speed Europe”.

Three-speed Europe would be more accurate. As Lewandowski’s remarks indicated, EU member states in central and eastern Europe are angry. They are being excluded from the Franco-German debate about the future economic governance of a eurozone that they are committed to join. Unlike the Poles, peripheral eurozone debtor-nations such as Greece, Ireland and Portugal do at least have a seat at the Eurogroup table – if only as supplicants.

Increasing inter-governmentalism led by Germany and France is leaving the European Commission feeling sidelined too. Which explains Commission President José Manuel Barroso’s insistence that the Commission has a “right and a duty” to make public its views on eurozone economic governance.

It is only to be expected that Barroso would climb the ramparts to defend the Commission’s role, but he should be careful. What the EU and the eurozone need most now is decisive leadership, which Germany and France are providing. Barroso should not, for example, get in the way of plans for the most rigorous economic governance regime that these two big EU states can agree on.

In such perilous times, Europe must also make sure that top jobs are filled on merit, and resist the distractions of regional, institutional, or big-state, small-state balance. The Commission should get behind the probable appointment of Italy’s central bank governor Mario Draghi to succeed Jean-Claude Trichet as president of the European Central Bank (ECB). It should resist getting drawn into attempts to balance the ECB appointment with the choice of who to succeed the lacklustre Jean-Claude Juncker as head of the Eurogroup. The simplest and best choice there would be Herman Van Rompuy, the president of the European Council, who has already been chairing the taskforce on economic governance. Although the Commission has hitherto been jealous of Van Rompuy’s powers, in this instance, it should just let him get on and make the Eurogroup more effective than it has been under Juncker’s chairmanship.

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Stewart Fleming is a freelance journalist based in London.