The Two Rebalancing Acts

By Olivier Blanchard

Achieving a “strong, balanced, and sustained world recovery”—to quote from the goal set in Pittsburgh by the G-20—was never going to be easy. It requires much more than just going back to business as usual. It requires two fundamental and complex economic rebalancing acts.

First, internal rebalancing. When private demand collapsed, fiscal stimulus helped reduce the fall in output. This helped avoid the worst. But private demand must now become strong enough to take the lead and sustain growth, while fiscal stimulus gives way to fiscal consolidation.

The second is external rebalancing. Many advanced countries, most notably the United States, relied excessively on domestic demand before the crisis, and they must now rely more on net exports. Many emerging market countries, most notably China, had relied excessively on net exports, but must now look to domestic demand.

Too slow

These two rebalancing acts are taking place too slowly.

Private domestic demand remains weak in advanced countries. This reflects both a correction of pre-crisis excesses and the scars of the crisis. U.S. consumers who had overborrowed before the crisis are now saving more and consuming less; while this is good for the long run, it is a drag on demand in the short run. Housing booms have given way to housing slumps, and housing investment will remain depressed for some time to come. And financial system weaknesses are still constraining credit.

External rebalancing remains limited. Net exports are not contributing to growth in advanced countries; the US trade deficit remains large. Many emerging markets continue to run large current account surpluses, and to respond to capital inflows primarily through reserve accumulation rather than exchange rate appreciation. International reserves are higher than they have ever been and continue to increase.

The result is a recovery which is neither strong, nor balanced, and runs the risk of not being sustained. For the last year or so, inventory accumulation and fiscal stimulus were driving the recovery. The first is coming to a natural end. The second is slowly being phased out. Consumption and investment now have to take the lead. But, in most advanced economies, weak consumption and investment, together with little improvement in net exports, are leading to low growth. Unemployment is high, and barely decreasing.

By contrast, in many emerging market countries, where excesses were limited and the scars of the crisis are few, consumption, investment, and net exports are all contributing to strong growth, and output is back close to potential.

Policy implications

So, what are the policy implications? What can be done to improve things?

First, wherever private demand is weak, central banks should continue with accommodating monetary policy. One should be realistic however. Not much more can be done, and one should not expect too much from further quantitative or credit easing. While there is no evidence yet that sustained low interest rates are leading to excessive risk taking, were such risks to materialize, they should be addressed through macro prudential measures, not through increases in policy rates.

Second, and wherever needed, governments must continue both financial repairs and financial reforms. Many banks do not have enough capital, and tight credit is constraining segments of demand. Securitization, which must play an important role in any financial system in the future, is still moribund. Financial reforms are proceeding, but questions remain about “too big to fail” institutions, about the perimeter of regulation, and about cross border issues. The faster reform uncertainty is reduced, the more the financial system will support demand and growth.

Third, and again wherever needed, governments must address fiscal consolidation. What is essential here is not to so much to phase out fiscal stimulus now, but to offer a credible medium term plan for debt stabilization and, eventually, for debt reduction. Such credible plans may involve fiscal rules, the creation of independent fiscal agencies, and phased-in entitlement reforms. They have not yet been offered in most countries. But they are essential because, when in place, this will give government more fiscal flexibility to sustain growth in the short run.

Fourth, those emerging market countries with large current account surpluses must accelerate rebalancing. This is not only in the world economy’s interest, but also their own. In many of these countries, distortions have led to too low a level of consumption, or too low a level of investment. Removing these distortions and thus allowing consumption and investment to increase is highly desirable. To a large extent, market forces, in the form of large capital inflows, are pushing these countries in the right direction. However, to the extent that some countries do not allow for sufficient exchange rate adjustment, this exacerbates the problem for others. The use of reserves should be limited, and the role of capital controls, if any, should be to direct flows in accord with macroprudential concerns, not to prevent necessary exchange rate shifts.

All these pieces are very much interconnected. Unless advanced countries can count on stronger private demand—both domestic and foreign—they will find it difficult to achieve fiscal consolidation. And worries about sovereign risks can easily derail growth. If growth stops in advanced countries, emerging market countries will have a hard time decoupling. These downside risks, which were described in the GFSR, should not be ignored.

The need for careful design at the national level, and coordination at the global level, may be even more important today than they were at the peak of the crisis a year and a half ago.

10 Responses

  1. First, internal rebalancing. When private demand collapsed, fiscal stimulus helped reduce the fall in output. This helped avoid the worst. But private demand must now become strong enough to take the lead and sustain growth, while fiscal stimulus gives way to fiscal consolidation.

    The second is external rebalancing. Many advanced countries, most notably the United States, relied excessively on domestic demand before the crisis, and they must now rely more on net exports. Many emerging market countries, most notably China, had relied excessively on net exports, but must now look to domestic demand.”

    It’s been about two years now and I still can’t see their goal of re-balancing working. China is still heavily exporting and is massively affecting trade not only in Asia but in other parts of the world as well.

  2. is not hard to see why the trade performance has been disappointing. Britain’s manufacturing base has just been through its third big shake-out of the past 30 years and no longer has the critical mass necessary to capitalize on a cheaper pound. Globalized production means that the import component of exports has risen, so the benefits of currency depreciation have been blunted.

  3. [...] policy advice to advanced countries remains largely the same as in previous World Economic Outlooks, and so far, has been only partly heeded. Increased clarity on banks’ exposures with ready [...]

  4. [...] policy advice to advanced countries remains largely the same as in previous World Economic Outlooks, and so far, has been only partly heeded. Increased clarity on banks’ exposures with ready [...]

  5. [...] policy advice to advanced countries remains largely the same as in previous World Economic Outlooks, and so far, has been only partly heeded. Increased clarity on banks’ exposures with ready [...]

  6. When the United States government borrows money from the People’s Republic of China it is not an import export matter. It is merely a way of blaming government spending on foreigners instead of the actual officials who authorize the spending and borrowing.

  7. When the problems are structural, don’t look for success in traditional central bank policy alternatives based on this structure. Look for structural solutions.

    The analysis to date is somewhat limitied but very much focuses on the pro-cyclicality of the systems within the structure as the central cause of the financial and monetary crisis.

    The financialization of the economy and regulatory capture are two sub-causes of the pro-cyclicality in the system. The major cause is innate to the debt-money system itself, the only system the IMF has known since its inception.

    Is the IMF capable of seeing beyond its own self-imposed limitations with how monetary systems should function, and can function, in order to actually provide both the financial stability and the economic stability that monetary systems should be capable of providing?

    Are we analyzing the potential for calamitous results, the amount at risk, against our alternative investment strategies for saving the global economy?
    Is there an exit-strategy group?

    If the IMF is capable of self-evaluation, then maybe we have a chance. If it chooses to perpetuate the chaos of the debt-money system, rather than considering Dr. Yamaguchi’s alternative macro-economic monetary structure, well, there goes the baby.

  8. “The result is a recovery which is neither strong, nor balanced, and runs the risk of not being sustained.”

    The obvious question then is: “Is that a recovery?”.
    Or, is it the result of massive but mis-directed monetary policy?

    It has been proven that ZIRP cannot push the economy back to recovery. So the main monetary policy tool is at best ineffective.
    It has also been proven that the modern-day solution when ZIRP fails, that of QME, is yet another failed monetary policy tool.

    What to do, IMF? The answer is a new macroeconomic paradigm that will allow the reduction of our national debts, the restoration of economic growth and a lack of inflationary and deflationary pressures. That answer has already been found and proven by Dr. Kaoru Yamaguchi of Japan’s prestigious Doshisha University who reported his results in a paper titled: “On the Liquidation of Government Debt under a Debt-Free Money System – Modeling the American Monetary Act”.

    The question for the IMF is whether it will maintain credibility in its role as the central bankers’ banker and the font of international macro-economic research in the face of the truth that the system the IMF is using to engineer the global economy is itself flawed.

    Dr. Yamaguchi’s paper is available here:
    http://www.systemdynamics.org/cgi-bin/sdsweb?P1061+0

    An interview in which he discusses these results is here:

    http://www.youtube.com/user/EconomicStability#p/a/u/0/iONSua-cvkE

    Thanks.

  9. I agree in the diagnosis and in the remedies but would like to add the following which I sincerely believe is what we most need in order to break out of the economic and mental stagnation we find ourselves immerse in.

    Oliver Blanchard correctly states that “Many banks do not have enough capital, and tight credit is constraining segments of demand” The reason for this though is that what had good ratings before and therefore required only very low capital requirements now, as they either default or their ratings deteriorate, they sponge up all available capital leaving those perceived as “risky” out in the cold, since though they had nothing to do with causing the crisis they still generate higher capital requirements for the banks.

    We should temporarily lower the capital requirements for what is considered as risky and thereafter lift the capital requirements equally for all.

    Don’t worry, those who are perceived as risky do not pose dangers for the banks, because in dealing with them the banks are more than careful, traditionally they are even closer to being real cowards

  10. There are good reasons to recognize that interest rates and exchange rates are blunt instruments that can only do so much when the problems are structural.
    It will be important and desirable to hear the views of the IMF Chief Economist on on ZIRP and QE in the US and UK?

    In Zero interest rate policy: Andrew Sheng and I pointed out as early as 2009 that treatment may be as expensive as the crisis and if anything the problems of distortions, bubbles, and capital flows are getting worse–
    blogs.ft.com/…/zero-interest-rate-policy-treatment-may-be-expensive-as-the-crisis/

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