«EXPERT REPORT NO. 36 TO SWEDEN’S GLOBALISATION COUNCIL Globalisation, the ﬁnancial crisis and stabilisation policies Torben M. Andersen Peter ...»
Globalisation, the ﬁnancial
crisis and stabilisation policies
EXPERT REPORT NO. 36 TO SWEDEN’S GLOBALISATION COUNCIL
Globalisation, the ﬁnancial crisis
and stabilisation policies
Torben M. Andersen
Expert report no. 36 to Sweden’s Globalisation Council
EXPERT REPORT NUMBER 36 TO SWEDEN’S
(C) THE GLOBALISATION COUNCIL 2009 AUTHOR Torben M. Andersen, Peter Englund, Stefan Gerlach GRAPHIC DESIGN Nina Gergi ORIGINAL Pangea Design PHOTO COVER Colourbox PRINT Edita, Västerås 2009 ISBN 978-91-85935-35-2 ISSN 1654-6245 ORDER The Globalisation Council PHONE 0046 8 405 10 00 E-MAIL firstname.lastname@example.org www.sweden.gov.se/globalisation Preface The recent wave of globalisation - and the effects of the global ﬁnancial crisis - raises new questions on the role of stabilisation policy. The mainstream consensus view is that stabilisation policy should be left to monetary policy pursuing credible policy rules with a focus on inﬂation. On the other hand, most macroeconomists would argue that ﬁscal policy should rely on the automatic stabilisers, restraining discretionary ﬁscal policy to very special circumstances with a clearly identiﬁed need for policy intervention. Are those commonly held wisdoms still true in today’s globalised world?
The report aims to shed light on the following issues. First, how does the current global ﬁnancial crisis inﬂuence the need and scope for monetary and ﬁscal policy? Second, is globalisation the cause of the present turmoil or are there other explanations that should be invoked? Finally, to what extent can the lack of regulations and supervision of global ﬁnancial markets be held accountable for the recent downturn, and which remedies can be implemented to avoid a similar situation to emerge in the future?
In the ﬁrst chapter Torben M. Andersen focuses on the implications of the crisis for ﬁscal policy. He emphasises the role of automatic stabilisers in normal situations, but advocates a more active ﬁscal policy strategy when the economy is exposed to severe and idiosyncratic shocks. The degrees of freedom in pursuing such strategy is discussed, as is the preferable instruments - based on their multiplier effects - to be used. Torben Anderson also conclude that leakages across countries associated with ﬁscal policies calls for more of coordination to avoid free passenger problems and to make sure that the taken measures are effective. He strongly favours labour market policies to prevent unemployed to get marginalised and lose contact with the labour market. The conceivable tension between short and long-run objectives is also discussed. Thus, the present situation makes a case for active ﬁscal policy in order to boost aggregate demand, simultaneously as the crisis necessitates structural adjustments. That has to be taken into account in order to avoid that policy measures impede a basically sound restructuring of the economy.
Peter Englund focuses on the mechanisms of modern ﬁnancial markets that made it possible for losses, initially related to U.S.
housing ﬁnance, to give rise to a world-wide crisis. In addition, a number of reforms to circumvent future ﬁnancial crises are suggested. He identiﬁes plenty of shortcomings in the current regulatory system and argues for a more global approach to address ﬁnancial market regulation. These are critically important for the functioning of any economy, and they are interconnected through a global web of ﬁnancial institutions and agents. Hence, shocks are easily transmitted across these ﬁnancial networks. In a world of international capital markets and cross-border banking, it is not possible for any nation to protect its banking system simply by a national system of regulation.
In the ﬁnal chapter Stefan Gerlach tries to ﬁnd answers to the crucial issue on what factors led to the crisis. In particular, how did globalisation impact the crises? A second question concerns what policy responses are warranted to prevent future ﬁnancial crises.
Gerlach analyses the low inﬂation policies in recent decades and explores the hypothesis that monetary policy set the stage for the crisis by depressing long real yields and triggering the search for yield. He also discusses the crisis from a ﬁnancial stability perspective. He argues that the main cause of the crisis was a global imbalance in the rate of savings, i.e. he ﬁnds support for the “saving glut” hypothesis, combined with poor incentives and ineffectual regulation and supervision. However, according to Stefan Gerlach, that should not be interpreted as if there is no important role for monetary policy to play. Rather the contrary, the independence of central banks and the design of monetary policies, is the main cause of decreasing inﬂation while globalisation may have had an indirect but limited effect on inﬂation. Still, the challenges ahead are substantial. In the short term those relate to the deﬂation threats that have emerged in several countries, while in the longer term the enormous liquidation of the markets should constitute a risk of higher inﬂation expectations.
The authors are all well-renowned professors in economics: Torben M. Andersen, School of Economics and Management, Aarhus University, Peter Englund, Department of ﬁnance, Stockholm School of Economics, and Stefan Gerlach, Institute for Monetary and Financial Stability, University of Frankfurt. The authors take full responsibility for the results and the analyses presented in this report.
Stockholm, May 2009 Pontus Braunerhjelm Principal Secretary, The Globalisation Council Globalisation Council members The Swedish Government has established a Globalisation Council to promote a deeper knowledge of globalisation issues, draw up economic policy strategies and broaden public dialogue about what needs to be done to ensure that Sweden can compete successfully in a world marked by continued rapid globalisation. The Council’s work is expected to lead to proposed measures whose purpose, broadly deﬁned, will be to boost Sweden’s competitiveness and attractiveness on the international scene.
In addition to regular Council meetings, background reports will be written by independent researchers and other experts. These will be quality assessed by reference groups composed of representatives from academia and the Government Ofﬁces and by leading economists on the Council’s Advisory Board. The work of the Council, which must be completed well before the 2010 general election, will be documented in a ﬁnal report along with economic policy recommendations.
Plans are also being drawn up for a number of external activities, such as conferences and seminars.
The Council comprises representatives from the business sector, the Government, social partners, the government administration, the media and the research community. It is chaired by the Minister for Education and Research, Lars Leijonborg. The Principal Secretary is Pontus Braunerhjelm.
The other members are:
• Kristina Alsér, Mercatus Engineering AB, County Governor, Kronoberg County
• Hans Bergström, columnist and reader in political science
• Carl Bildt, Minister for Foreign Affairs
• Urban Bäckström, Director-General, Confederation of Swedish Enterprise (Svenskt Näringsliv)
• Lars Calmfors, professor of international economics
• Per Carstedt, Chair, BioAlcohol Fuel Foundation
• Dilsa Demirbag-Sten, journalist, author
• Anna Ekström, Chair, Swedish Confederation of Professional Associations (SACO)
• Lars Leijonborg, Minister for Higher Education and Research
• Sven Otto Littorin, Minister for Employment
• Wanja Lundby-Wedin, President, Swedish Trade Union Confederation (LO)
• Karin Markides, President, Chalmers University of Technology
• Elisabeth Nilsson, President, Swedish Steel Producers’ Association (Jernkontoret)
• Aina Nilsson Ström, Head of Design, AB Volvo
• Sture Nordh, Chair, Swedish Confederation of Professional Employees (TCO)
• Mats Odell, Minister for Local Government and Financial Markets
• Maud Olofsson, Minister for Enterprise and Energy and Deputy Prime Minister
• Carl-Henric Svanberg, President and CEO, Ericsson
• Lena Treschow Torell, Chair, Royal Swedish Academy of Engineering Sciences (IVA)
• Harriet Wallberg-Henriksson, President, Karolinska Institutet
• Marcus Wallenberg, Chair, International Chamber of Commerce (ICC)
• Olle Wästberg, Director-General, Swedish Institute (Svenska Institutet)
GLOBALISATION, THE FINANCIAL CRISIS AND STABILISATION POLICIES • 5Table of contents
GLOBALISATION, THE FINANCIAL CRISIS AND STABILISATION POLICIES • 7Fiscal policy and the global ﬁnancial crisis February 2009 Torben M. Andersen School of Economics and Management Aarhus University CEPR, IZA, CESifo, and Swedish Fiscal Policy Council.
8 • EXPERT REPORT NO. 36 TO SWEDEN’S GLOBALISATION COUNCIL
1. Introduction The global ﬁnancial crisis is now turning into a worldwide economic crisis. Business cycle forecasts are continuously being revised downwards1 and negative growth rates are expected in many OECD countries for 2009, cf. ﬁgure 1. Growth rates are expected to recover only sluggishly, and consequently unemployment rates are soaring in all OECD countries.
Figure 1: Forecast adjustments:
OECD growth forecasts for 2009: June and December 2008 2.5 2.0 1.5 1.0 0.5
Against this background, political interest in ﬁscal policy as a possible remedy is increasing. For some years ﬁscal policy has been downplayed, but it now faces a renaissance with high expectations In January, IMF (2009) revised the projected world growth rate for 2009 downwards to 0.5 per 1 cent, In November 2008 it was forecast to be 2.25 per cent, and in July 2008 3.9 per cent. The EU Commission (2009) has adjusted the projected growth rate for 2009 down by 2 percentage points to
-0.2 per cent between autumn 2008 and January 2009.
GLOBALISATION, THE FINANCIAL CRISIS AND STABILISATION POLICIES • 9as to what ﬁscal policy can accomplish. In many countries, there is a lively debate on the need for a ﬁscal stimulus, its magnitude, and its composition, and some countries have undertaken ﬁscal stimulus packages. Leaders at the G20 summit, the EU Commission and many others have called for a coordinated ﬁscal stimulus.
The revival of ﬁscal policy raises two questions: what role can ﬁscal policy play in the current situation and what does past experience teach us about ﬁscal policy? The views on ﬁscal policy prevailing before the onset of the crisis were heavily inﬂuenced by events triggered by the ‘oil crisis’, when there were widespread attempts to manage the crisis with demand management policies. Policies during that period were not particularly successful. This can largely be attributed to the misperception that the crisis was temporary and to a neglect of structural aspects.2 Another important lesson is the trade-off between short- and long-run objectives. High levels of debt accumulated during the 1970s and 1980s have turned out to be a signiﬁcant burden and constraint on policy options for a number of countries for prolonged periods of time. For some countries, these problems had not been fully solved before the onset of this crisis. At the same time, the approaching demographic shifts are challenging public ﬁnances still further.
The mainstream consensus view on macroeconomic policy can be summarised as follows.3 Stabilisation policy should be left to a monetary policy pursuing credible policy rules with a focus on inﬂation. Fiscal policy should rely on the automatic stabilisers (the rule-based part of ﬁscal policy), leaving discretionary ﬁscal policy only to special circumstances where there is a clear need for policy intervention (escape clause). Hence, well-known lag-problems should not lead to ﬁscal ﬁne-tuning, but ‘coarse-tuning’ is called for in special situations. The conditions for the latter clearly seem to be fulﬁlled in the current situation.
With the recent wave of globalisation, the current situation raises new questions. The cause of the crisis, and in particular its propagation, have a very strong global element driven by closer ﬁnancial and trade links. At the same time, this also signiﬁcantly inﬂuences the effects of ﬁscal policy since increased demand See e.g. Andersen (1990) for an account and discussion of policy strategies in the Nordic countries.
2 This is clear in the ‘Maastricht assignment’ for the European Monetary Union, which leaves 3 centralised monetary policy to stabilise inﬂation, and decentralised ﬁscal authorities to stabilise national output by relying primarily on the automatic stabilisers.
10 • EXPERT REPORT NO. 36 TO SWEDEN’S GLOBALISATION COUNCIL leakages via trade and specialisation of production may make ﬁscal instruments less effective. If either of these factors is important, it may, however, point to larger gains from policy coordination than in the past. However, it is not clear that the political barriers and obstacles to beginning coordinating stabilisation efforts have been reduced. This may cause a ‘stabilisation deﬁcit’ tending to worsen the depth and duration of the crisis.
The aim of this paper is to discuss the need and scope for ﬁscal policy in light of the global ﬁnancial crisis. It is not the aim here to give a general account of ﬁscal policy, but rather to focus on issues particularly relevant in the current situation. First, a few general remarks on the nature of the crisis and the role of ﬁscal policy are highlighted in section 2. Next, the role of automatic stabilisers and their strength are discussed in section 3. Some crucial aspects of the effectiveness of ﬁscal policy are discussed in section 4, while section 5 considers speciﬁc aspects of ﬁscal policy design in the current situation. The possible tension between short- and long-run objectives is discussed in section 6, and section 7 considers coordination issues. Finally, section 8 offers some concluding remarks.