Global eco­nomic tsars need to have a re­think

The Pak Banker - - OPINION - Mo­hamed A. El-Erian

JUST when the no­tion that Western economies are set­tling into a "new nor­mal" of low growth gained main­stream ac­cep­tance, doubts about its con­tin­ued rel­e­vance have be­gun to emerge. In­stead, the world may be headed to­ward an eco­nomic and fi­nan­cial cross­roads, with the di­rec­tion taken de­pend­ing on key pol­icy de­ci­sions.

In the early days of 2009, the "new nor­mal" was on vir­tu­ally no one's radar. Of course, the global fi­nan­cial cri­sis that had erupted a few months ear­lier threw the world econ­omy into tur­moil, caus­ing out­put to con­tract, un­em­ploy­ment to surge, and trade to col­lapse. Dys­func­tion was ev­i­dent in even the most sta­ble and so­phis­ti­cated seg­ments of fi­nan­cial mar­kets. Yet most peo­ple's in­stinct was to char­ac­terise the shock as tem­po­rary and rev­ersible - a V-shape dis­rup­tion, fea­tur­ing a sharp down­turn and a rapid re­cov­ery. Af­ter all, the cri­sis had orig­i­nated in the ad­vanced economies, which are ac­cus­tomed to man­ag­ing busi­ness cy­cles, rather than in the emerg­ing-mar­ket coun­tries, where struc­tural and sec­u­lar forces dom­i­nate.

But some ob­servers al­ready saw signs that this shock would prove more con­se­quen­tial, with the ad­vanced economies find­ing them­selves locked into a frus­trat­ing and un­usual long-term low-growth tra­jec­tory. In May 2009, my Pimco col­leagues and I went pub­lic with this hy­poth­e­sis, call­ing it the "new nor­mal". The con­cept re­ceived a rather frosty re­cep­tion in aca­demic and pol­icy cir­cles - an un­der­stand­able re­sponse, given strong condi- tion­ing to think and act cycli­cally. Few were ready to ad­mit that the ad­vanced economies had bet the farm on the wrong growth model, much less that they should look to the

But the econ­omy was not bounc­ing back. On the con­trary, not only did slow growth and high un­em­ploy­ment per­sist for years, but the in­equal­ity tri­fecta (in­come, wealth, and op­por­tu­nity) wors­ened as well. The con­se­quences ex­tended be­yond eco­nom­ics and fi­nance, strain­ing re­gional political ar­range­ments, am­plify­ing na­tional political dys­func­tion, and fu­elling the rise of anti-es­tab­lish­ment par­ties and move­ments.

With the ex­pec­ta­tion of a V-shape re­cov­ery in­creas­ingly dif­fi­cult to jus­tify, the "new nor­mal" fi­nally gained wide­spread ac­cep­tance. In the process, it ac­quired some new la­bels. In­ter­na­tional Mon­e­tary Fund Man­ag­ing Di­rec­tor Chris­tine La­garde warned in Oc­to­ber 2014 that the ad­vanced economies were fac­ing a "new medi­ocre". For­mer US Sec­re­tary of the Trea­sury Larry Sum­mers fore­saw an era of "sec­u­lar stag­na­tion".

To­day, it is no longer un­usual to sug­gest that the West could linger in a low-level growth equilibrium for an un­usu­ally pro­longed pe­riod. Yet, as I ex­plain in my new book The Only Game in Town: Cen­tral Banks, In­sta­bil­ity, and Avoid­ing the Next Col­lapse, grow­ing in­ter­nal ten­sions and con­tra­dic­tions, to­gether with over­re­liance on mon­e­tary pol­icy, are desta­bil­is­ing that equilibrium.

In­deed, with fi­nan­cial bub­bles grow­ing, the na­ture of fi­nan­cial risk mor­ph­ing, in­equal­ity wors­en­ing, and non-tra­di­tional - and in some cases ex­treme - political forces con­tin­u­ing to gain trac­tion, the calm­ing in­flu­ence of un­con­ven­tional mon­e­tary poli­cies is be­ing stretched to its lim­its. The prospect that such poli­cies will be able to keep the eco­nomic en­gines hum­ming, even at low lev­els, looks in­creas­ingly dim.

In­stead, the world econ­omy seems to be headed for an­other cross­roads, which I ex­pect it to reach within the next three years.

This may not be a bad thing. If pol­i­cy­mak­ers im­ple­ment a more com­pre­hen­sive re­sponse, they can put their economies on a more sta­ble and pros­per­ous path - one of high in­clu­sive growth, de­clin­ing in­equal­ity, and gen­uine fi­nan­cial sta­bil­ity.

Such a pol­icy re­sponse would have to in­clude pro-growth struc­tural re­forms (such as higher in­fra­struc­ture in­vest­ment, a tax over­haul, and labour re­tool­ing), more re­spon­sive fis­cal pol­icy, re­lief for pock­ets of ex­ces­sive in­debt­ed­ness, and im­proved global co­or­di­na­tion. This, to­gether with tech­no­log­i­cal in­no­va­tions and the de­ploy­ment of side­lined cor­po­rate cash, would un­leash pro­duc­tive ca­pac­ity, pro­duc­ing faster and more in­clu­sive growth, while val­i­dat­ing as­set prices, which are now ar­ti­fi­cially el­e­vated.

The al­ter­nate path, onto which con­tin­ued political dys­func­tion would push the world, leads through a thicket of parochial and un­co­or­di­nated poli­cies to eco­nomic re­ces­sion, greater in­equal­ity, and se­vere fi­nan­cial in­sta­bil­ity. Be­yond harm­ing the eco­nomic well­be­ing of cur­rent and fu­ture gen­er­a­tions, this out­come would un­der­mine so­cial and political co­he­sion. There is noth­ing pre­des­tined about which of th­ese two paths will be taken. In­deed, as it stands, the choice is frus­trat­ingly im­pos­si­ble to pre­dict.

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