At the IMF-World Bank meetings this past week, there were plenty of assessments of the state of the global economy that described the post-2008 recovery as anemic. Only a few went so far as to claim that the global economy is comatose. Yet, despite general agreement on the diagnosis, there was little consensus on how to solve the problem. Deciding on what tools and policies to use to stimulate growth is vital if we are going to cure the global economy of persistent enervation.
For a number of years, we’ve been led to believe that fiscal consolidation or austerity — code for cutting government budgets — is the best way to stimulate economic growth. Supposedly, it triggers a virtuous cycle: by increasing the confidence of the private sector, it spurs investment, which leads to economic growth, which further increases confidence, which in turn fuels more growth. It is this fiscal belt-tightening that eventually improves the health of the entire economy. So we are told by influential economists.
The highly prominent Harvard University’s Rogoff-Reinhart thesis in 2010 which claimed to show that in highly indebted countries, economic growth will cease or retreat once a magic threshold debt level of 90 per cent of GDP is passed, is but one example among many studies that have been used to support this theory of “expansionary austerity.” Now it seems that these two economists were omitting important data points and even succumbed to a simple coding error, which casts doubt on their analysis, and on the theory of expansionary austerity itself.
Fiscal consolidation can sometimes lead to economic growth; whether it will depends on a slew of other important variables such as interest rates (when they’ve already reached the zero lower-bound), the type of exchange rate in place (a floating exchange rate can help dampen the effects of fiscal contraction); and how supportive external demand is for an economy’s goods and services. In the case of Canada in the 1990s, the country was fortunate that it undertook fiscal consolidation with the support of these three variables. For some countries this may not be the case, so we should be cautious of blanket arguments in favour of fiscal consolidation.
To be fair, Rogoff-Reinhart never did explicitly claim causation, only correlation. Note that the the Rogoff-Reinhart findings — even if the original results still held — tell us very little if low growth leads to high debt (think Japan) or if high debt leads to low growth (think Greece). This, however, did not stop influential policymakers and politicians like former Republican Vice-Presidential candidate Paul Ryan and European Commissioner Olli Rehn from taking these findings and spinning them to support their own political agendas.
The sole point however is not whether some growth occurs — it is what kind of growth that should concern us; for growth that results from consolidation is more often anemic than vigorous. Moreover, economic growth alone is not a satisfying benchmark to measure the economy’s recovery and future prospects. We need to ask: How do we get economic growth that is inclusive? And what indicators will tell us we’re on the right track? “Inclusive” in this context is code for JOBS, and jobs are what we need to be tracking most closely. What is the point of having overall economic growth if this doesn’t translate into people working and their wages increasing over time? Without job creation, we cannot increase consumption and generate the tax revenues needed to make important investments in education, health, R&D, and infrastructure, which taken together are prerequisites for long-term economic growth. In other words, without jobs, we get stuck on an anemic economic growth path. This is where we are now, and this is what needs the attention of world policymakers.
Indeed if there are any policy “heroes” of the Great Recession, they are the major central banks of the developed world. These institutions have proven remarkably adept at putting a floor under asset values, and a ceiling above credit spreads. But even with recourse to all this “unconventional” monetary policy, policymakers have still failed to put a ceiling above what truly matters: the unemployment rate. I hope that at the next IMF-World Bank meetings, job creation will be at the top of the agenda. And I hope that we will take the Rogoff-Reinhart thesis as a reminder that what’s needed are careful assessments of what each country can do to create jobs, not a one-size-fits-all fiscal fix.