By Anoop Singh
It was Aristotle who said “one swallow does not a summer make, nor one fine day.” Perhaps if Aristotle had been an IMF economist living in current times, he might have said “a few green shoots do not a recovery make.” Despite budding green shoots in Asia, policymakers in the region will need to be cautious about how they sustain this fragile recovery. In the coming year, they will need to pull off a difficult balancing act.
On the one hand, they need to continue providing extensive macroeconomic support to their economies until it is clear that the recoveries are sufficiently robust and sustainable. On the other hand, they have to make sure that stimulus is not maintained for so long that it ignites asset price bubbles, inflation pressures, or concerns about fiscal sustainability.
Where policymakers strike this balance will depend on a prior assessment: they will need to decide whether private demand has become strong enough to substitute for a withdrawal of public sector demand.
And if that isn’t difficult enough, this assessment will need to be forward-looking, at a time when the economic outlook has become exceptionally uncertain.
In figuring out how to pull off this delicate balancing act, the lessons of the past may prove instructive. So, Chapter II of the latest Regional Economic Outlook for Asia and the Pacific, launched last week in Seoul and Tokyo, looks at the experience of Japan, when it emerged from its 1990s banking crisis.
Here is what we concluded :
- “Green shoots” do not guarantee a sustained recovery. On two occasions, emerging recoveries allowed stimulus to be withdrawn. However, both times the external environment subsequently deteriorated dramatically, and the shock to the economy was magnified by a still-fragile financial system. A more severe downturn ensued, necessitating even more aggressive stimulus.
- Sustained recoveries may not take hold until balance sheet problems at the heart of the crisis are addressed. A durable recovery took hold only after Japan’s banks became more aggressive about dealing with problem loans and capital shortages; and corporations finally shed the “triple excesses” of debt, capacity, and labor.
- While this restructuring is under way, policy stimulus may need to be maintained.
- Policymakers need to clarify “exit strategies.” At an early stage, they should set out medium-term plans for fiscal consolidation and specify the conditions under which monetary accommodation will be withdrawn.
These lessons can readily be applied to today’s conditions. Notwithstanding the sprouting “green shoots”, one needs to be cautious about the outlook. Private demand in advanced countries could remain weak for a prolonged period, until households reduce their debts to more normal levels and banks repair their balance sheets.
Meanwhile, Asian domestic demand could also remain weak, since such spending typically revives only after exports start booming and associated incomes start flowing through the economy — at least in the more export-oriented nations. This all adds up to continued stimulus for the time being.
Of course, different countries are facing different situations. In particular, countries with large domestic markets, such as China and India have smaller output gaps, since they were not hit as hard by the crisis and have more advanced recoveries. So, they might need to tighten before some of their Asian neighbors. But most of Asia faces a different imperative. They may need to maintain policy stimulus for some time to come.