Stability in the financial system

How well has the global economy recovered from the great recession of 2008?

I don’t think the global financial crisis continues to be a dominant issue for the global economy in the way that it was. There’s substantial scar tissue in terms of people who were thrown out of work or never got work back, in terms of capital that was not invested. I think there’s probably regret both that the crisis took place and that there was too quick a declaration of victory after the crisis.

What would you identify as the central issues facing the global economy today?

I think the most profound long-run issue, for the industrialised world at least, relates to secular stagnation. We have a global economy that has great difficulty growing except with very substantial levels of fiscal stimulus and/or very rapid growth rates in private credit creation – neither of which may be permanently sustainable. At the same time we have a global economy that is very brittle because the standard strategy for responding to downturns – with a 500 basis point cut in interest rates – is not feasible given the current low level of interest rates in most of the industrialised world.

A second, larger, more immediate issue is the rise of economic nationalism. It manifests in tariff barriers, restrictions on foreign investment, hostility towards immigrants and people from other nations, and reluctance to cooperate on international issues. It reflects a growing populist authoritarian tendency. The United States has traditionally been, in an imperfect but generous way, an underwriter of a globally oriented system. The combination of a nationalist turn in US policy, a Chinese approach that privileges national advantage over international responsibility and growing frustration in many other countries calls into question whether the global system is capable of coming together in response to problems in the way that it did at the G20’s London Summit in 2009.

A third challenge is that complacency can be a self-denying prophecy. After several years of significant recovery and in periods of low interest rates, there’s a tendency towards increased borrowing, asset price inflation and unsustainable spending plans. We’ve already seen significant strains in some emerging markets. Whether that is transitory in particular countries or a broader global phenomenon remains uncertain. This will in part depend on the nature of the international policy regime going forward.

What about fiscal policies, mounting deficits and debt from governments?

I rather doubt a time of near-record-low unemployment is the right time for the kind of major fiscal expansion we’ve seen in the United States. The fiscal expansion was misguided in being channelled largely into tax cuts that will be saved by relatively wealthy people. But it’s also important to recognise that appropriate debt and deficit targets are related to levels of interest rates, and levels of real interest rates are now and lower – lower themselves and lower in prospect – than they have been historically.

Do you think the authorities have got it right with monetary policy?

I would stress that a 2% inflation target should be a symmetric target. If you’ve been below the 2% target for nine years and you’re not prepared for inflation rising above 2% in the 10th year, I can’t imagine when you would ever be prepared to accept inflation rising above 2%. Monetary policy authorities need to be very mindful of the lag between monetary policy and economic effects. When you’re in a shower where there’s a long lag between turning on the faucet and the temperature of the water changing, it’s easy to scald yourself. It’s easy to over-tighten because of the failure to see an immediate response of policy to interest rate hikes.

It appears there are successful bilateral trade discussions under way, but is there enough focus on the digitalisation of the economy?

There is a lot of nonsense being spoken about trade these days. Much that is fussed over is almost entirely cosmetic. The differences between the North American Free Trade Agreement and the new US-Mexico-Canada free trade agreement are tiny. I was a strong supporter of NAFTA and I’m a strong supporter of the new agreement. If I was an opponent of NAFTA, I can’t imagine why the small changes on rules of origin on cars and access to dairy in Canada would be sufficient to change my mind on the overall impact on the US economy. The psychological impacts are likely to be larger than the direct impacts, and those are very difficult to gauge. As Ronald Reagan said about nuclear wars, trade wars can never be won and should never be fought.

What should G20 leaders do at Buenos Aires to sustain, strengthen and spread today’s good economic growth?

They need to focus on containing the threat of economic nationalism and on making sure that there are satisfactory plans for responding to the next economic downturn whenever it comes, as well as continuing work to make sure the financial system is stable.