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Op-ed

Whistling Past the Graveyard

by Simon Johnson, Peterson Institute for International Economics

Originally posted at TNR.com
March 16, 2009

Expectations were low for this weekend's G-20 meeting of finance ministers and central bank governors. Despite that, we should be disappointed with the outcome.

There was no substantial progress on any policies that will help pull us out of a severe recession. The United States made a tactical mistake of pushing for a uniform two-percent fiscal stimulus across the G-20; not even the International Monetary Fund (IMF) is arguing for something so unrealistic. The Europeans were easily able to fight this off, pointing out that their stronger social safety nets mean they automatically stabilize their economies in ways that the United States can only do through discretionary fiscal packages.

The discussion should have focused on two important short-term macroeconomic issues: easing monetary policy further and establishing a financial stabilization fund for Europe. But monetary policy is effectively taboo at this kind of meeting, because of the prevailing fiction that central banks are independent and not subject to political interference. So the European Central Bank is free to continue with a stance that is inappropriately tight and threatens to plunge parts of the eurozone into deflation and widespread debt defaults.

And the most pressing need, a stabilization fund for Europe, was kept off the agenda by diplomatic niceties that increasingly belong to a bygone age. Leading countries do not criticize each other's massive policy mistakes too much because that would be, well, rude. So now they are turning a blind eye to the egregious EU policy mistakes with regard to Eastern-Central Europe and, increasingly, toward weaker eurozone countries, such as Greece and Ireland, despite the fact that this situation poses a first-order threat to the global financial system.

In this context, proposing to increase the profile of the Financial Stability Forum is laughable: This body has essentially achieved nothing in the past decade, other than offer a smokescreen for domestic regulatory failures.

The only slight ray of hope is the American idea to increase funding dramatically for the International Monetary Fund. In addition to enabling the Fund to help emerging markets as they increasingly fall into the danger zone, it should provide a backstop for the eurozone, in case France and Germany fail to provide it themselves.

Yet even on this dimension, the news on Saturday was bad. Treasury Secretary Timothy Geithner this week proposed an additional $500 billion for the IMF. This would constitute a bold and long-overdue tripling of its loanable resources. But the Western Europeans are, inexplicably, digging in around the idea that there should be only another $250 billion for the Fund (and they have not actually offered to pay anything themselves). Providing these resources has no budgetary implications and no other financial costs for the countries that choose to hold their reserves partly as a line of credit to the IMF. Without significant money for the IMF from European countries with deep pockets, though, there is no hope of attracting large-scale resources from emerging markets. And if the IMF is short of funds, it has no alternative but to negotiate tougher lending programs with countries that need external financial assistance. To you and me, the implications are simple and stark: a longer recession and a more difficult recovery. So why not do it?

It is, pure and simple, the kind of short-sighted and deluded European financial policy that prompted leading countries to demand that the IMF cut 20 percent of its most skilled and experienced personnel in early 2008, at the same time as Bear Stearns collapsed and major banks in almost every industrial country started to unravel. It is hardly believable, but nevertheless true, that the G-7 and now the G-20 have refused to undo the IMF cuts and replace essential staff.

If the G-20 heads-of-government summit on April 2 does no better, then we have a serious global problem, with both falling output and the prospect of an anemic recovery. What needs to happen at that summit? To start: We need agreement on further easing of monetary policy around the world. Europe needs a stabilization fund that can help weaker eurozone member countries and reduce the odds that they will be forced to borrow from the IMF. And we urgently need action to recapitalize and clean up problem banks around the world, particularly in the United States. The time for rearranging the deck chairs on the Titanic is over. Get some lifeboats in the water.

Simon Johnson is a senior fellow at the Peterson Institute for International Economics and a professor at MIT.

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Op-ed

Whistling Past the Graveyard