What G20 Leaders Must Do To Stabilise our Economy and Fix ... - Vox

VOXResearch-based policy analysis and commentary from leading economistsCrisis metastasisThe financial crisis has rapidly metastasised to the global economy in part because ofthe growth slowdown. But more immediately and importantly because asset pricesare falling and credit is drying up as capital is sucked back into the developedeconomies to restore damaged balance sheets, meet margin calls, and accommodateabnormally large volume redemptions. The result is that asset prices and exchangerates are being set by technical factors and the deleveraging process. They are largelyunrelated to reasonable assessments of longer term intrinsic value considerations.As a result, credit availability issues have emerged in a wide range of developingcountries. Dollar denominated liabilities have become more expensive, causing stressfor governments and companies – as in past developing-country crises. The differenceis that this one did not, for the most part, originate with them.After an unavoidable period of very high volatility in equity and debt markets, thiswill eventually end as the deleveraging storm abates and more normal valuations takehold. But the extent of the damage to household assets including pensions, henceconsumption and business investment, will have a significant impact on the depth,scope and length of the global recession.Coordinated interventions to reduce the damageA variety of coordinated interventions from central banks, the IMF, large holders ofreserves and others can help reduce the extent of an asset deflation overshoot andreduce the burden that is placed on fiscal policy and stimulus to restore economicgrowth. Specifically, we need to use the circuit breakers that we have to try to limit tospread of the asset deflation and its collateral damage.Well targeted fiscal stimulus programs will be needed; they should be combinedwith credible plans to restore fiscal balance and healthy public-sector balance sheetsover a period of time. The latter will be painful but necessary.Longer term agenda: System stabilityOn the longer term agenda of reform of the global financial system, a thoroughanalysis of the causes of the crisis is needed as a foundation; this should be based onextensive data analysis and involve multiple inputs.There is no shortage of potential contributing factors:• Incomplete and fragmented regulation, specifically unregulated mortgageorigination feeding the highly profitable securitisation business;• Global imbalances, and• Factors that led to a low inflation/low interest rate environment,• A variety of issues associated with incentives combined with incomplete andasymmetric information,• Transparency problems associated with the complexity of the assets and the factthat some derivatives are not traded, preventing the netting out of counterpartyrisk.These deserve and will receive serious attention as an analytical foundation for thedesign of more effective domestic and global regulation and oversight institutions.12