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Policy issues 81
Needless to say, this ideal sequencing is only feasible if the central government
balance sheet is strong enough to be leveraged up initially and thus contribute
to the deleveraging of the private sector. This was the case in Spain, for instance,
where public debt was very low at the beginning of the crisis, which allowed the
country to run larger deficits for longer, but not in Italy, which was forced into
steeper austerity and thus recession. In China, as mentioned above, the low debt
of the central government is a source of strength.
Sometimes, the ideal set of policies is prevented by the institutional setup. In
the Eurozone, for instance, the sequencing was jeopardised by the reluctance
of policymakers of core countries to put in place any form of transfer (either
fiscal or monetary) to the periphery. Indeed, it can be argued that the fear that
at some stage transfers would be necessary induced European policymakers to
force a steeper-than-necessary public sector deleveraging in the periphery. By the
same token, the possibly asymmetric impact of QE across member countries is a
political barrier to the introduction of non-standard monetary measures by the
ECB, a complicating factor not faced by the central banks of politically integrated
economies (such as the US, the UK or Japan).
5.2 Policy options. Where are we now
There is still a lot of work to do for policymakers. The legacy of the crisis is
still a major issue for a number of developed economies – especially in the euro
periphery – which remain extremely vulnerable, and ahead of the next financial
crisis, with early signs already visible this time around in some emerging
economies and especially in China.
Since the above-mentioned adverse combination of leverage and slower
nominal GDP has hurt global debt capacity, the path for successful deleveraging
policy looks quite narrow; indeed, there is a high likelihood of either a prolonged
period of very low growth or even another global crisis.
Policymakers are deeply divided on how to address the combination of high
debt, weak nominal growth and abundant global liquidity. The discussion is
made difficult by the uncertainty about the strength of the recovery in developed
markets and about the nature of the slowdown in some emerging markets.
We discuss below some key policy issues.
Issue 1. Monetary policy
Interest rates are at an historically low level and influential institutions (most
notably, the Bank for International Settlements) have warned that the world is
again in a situation in which a protracted low interest rate environment is creating
incentives for investors in search of yield to take excessive risk. According to this
view, financial regulation is not sufficient to prevent new excesses in leverage,
while central banks in countries where the economy is strengthening, such as
the US and the UK, should envisage an exit from very accommodative monetary
policies.