The latest economic data suggests that recession is returning to most advanced economies, with financial markets now reaching levels of stress unseen since the collapse of Lehman Brothers in 2008.The risks of an economic and financial crisis even worse than the previous one – now involving not just the private sector, but also near-insolvent sovereigns – are significant. So, what can be done to minimize the fallout of another economic contraction and prevent a deeper depression and financial meltdown.
1. If countries in the eurozone’s periphery are forced to undertake fiscal austerity, countries able to provide short-term stimulus should do so and postpone their own austerity efforts.
2. The European Central Bank should reverse its mistaken decision to hike interest rates. More monetary and credit easing is also required for the US Federal Reserve, the Bank of Japan, the Bank of England, and the Swiss National Bank. Inflation will soon be the last problem that central banks will fear.
3. To restore credit growth, eurozone banks and banking systems that are under-capitalized should be strengthened with public financing in a European Union-wide program
4. Large-scale liquidity provision for solvent governments is necessary to avoid a spike in spreads and loss of market access that would turn illiquidity into insolvency. Spain and Italy are at risk of losing market access. Official resources need to be tripled – through a larger European Financial Stability Facility (EFSF), Eurobonds, or massive ECB action – to avoid a disastrous run on these sovereigns.
5. Debt burdens that cannot be eased by growth, savings, or inflation must be rendered sustainable through orderly debt restructuring, debt reduction, and conversion of debt into equity. This needs to be carried out for insolvent governments, households, and financial institutions alike.
6. Competitiveness must be restored to the debtor countries. The sole alternative is an exit from the eurozone by Greece and some other current members. Only a return to a national currency – and a sharp depreciation of that currency – can restore competitiveness and growth.
7. The advanced economies need a medium-term plan to restore competitiveness and jobs via massive new investments in high-quality education, job training and human-capital improvements, infrastructure, and alternative/renewable energy. Only such a program can provide workers in advanced economies with the tools needed to compete globally.
8. Emerging-market economies have more policy tools left than advanced economies do, and they should ease monetary and fiscal policy. The International Monetary Fund and the World Bank can serve as lender of last resort to emerging markets at risk of losing market access, conditional on appropriate policy reforms. And countries, like China, that rely excessively on net exports for growth should accelerate reforms, including more rapid currency appreciation, in order to boost domestic demand and consumption.
The risks ahead are not just of a mild double-dip recession, but of a severe contraction that could turn into Great Depression II, especially if the eurozone crisis becomes disorderly and leads to a global financial meltdown. Wrong-headed policies during the first Great Depression led to trade and currency wars, disorderly debt defaults, deflation, rising income and wealth inequality, poverty, desperation, and social and political instability that eventually led to the rise of authoritarian regimes and World War II. The best way to avoid the risk of repeating such a sequence is bold and aggressive global policy action now.
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