With world economy stuttering, governments urged to open purse

WASHINGTON — World economic leaders are being urged to rally around a plan to let government do what it does best — spend money — in an effort to buoy a global economy that remains slack and slowing.

The effort comes as six years of crisis fighting have lapsed with little guarantee the global economy is on a stable footing. Even Germany is in danger of slipping into recession, China has slowed, and US policymakers are concerned a fresh world slowdown will stymie the US recovery as well.

International Monetary Fund (IMF) Managing Director Christine Lagarde made a blunt call on Thursday for the US and Germany in particular to open the taps and spend more on infrastructure projects — a stark reversal from the fund's recent fixation on government debt and "structural reform" that has proved politically difficult to implement.

"It is a question of doing it, not just talking about it," Lagarde said.

Her comments, and the rallying of top nations around the idea that government should begin spending again to boost growth and create jobs, comes amid recognition that the vast response of the past six years has not cured the world from the hangover of the Great Recession.

Developed economies have undertaken large fiscal adjustments and there is little sign political consensus will emerge in Washington for pump priming, let alone in Germany, the engine of the eurozone, where the top priority is to deliver on its promise of a federal budget that is in the black, or fully balanced, in 2015.

Historically loose monetary policy has pumped trillions of dollars into world markets, but much of the money remains idled as bank reserves or corporate cash holdings and too little has translated into investment and household spending. Trade and structural reform, touted as necessary to boost global growth, has proved too politically difficult to make a difference.

The aim now is to use an old-fashioned tool — the public purse — to step in where households, the private sector, banks and others have not.

"There has been a big drop in aggregate demand. Someone has to fill that gap," IMF Deputy Managing Director Min Zhu said at a panel as world finance ministers and central bankers here gathered for the IMF and World Bank fall meetings.

The IMF has couched its advice in typically prudent terms — that wise investments in infrastructure could boost jobs and growth in the short run, and pay for themselves over time by raising productivity and long-run economic potential.

Officials have estimated that developing nations like India and Brazil need trillions of dollars in capital spending in their own right, with Brazil often cited as a country whose economic growth is being hampered by an inefficient road and port system.

Economists at a panel on growth and government spending on Wednesday cited the United States as a developing nation whose roads, bridges and airports could use a facelift, improving growth and creating jobs in the near-term.

"We are looking at protracted low growth. There is a role for fiscal policy to play," said IMF Deputy Managing Director Naoyuki Shinohara, who added that even countries with high debt could find room to borrow for good projects. "There is fiscal room to be realised."

The IMF said Wednesday that advanced economies still hold too much debt, but even as they trim it they need to spend more to generate jobs.

After government debt loads soared in the crisis that began in 2008, they have now stabilised, the IMF's new assessment of global fiscal strength says. 

But debt, as a ratio to the gross domestic product (GDP), is still high and needs to be reduced further in the richest economies, it stressed.

The fund sees the average debt burden for advanced countries rising slightly to 106.5 per cent of GDP this year before slipping to 106 per cent by the end of next year.

For advanced economies as a group, "it is still expected to exceed 100 per cent of GDP at the end of the decade. It is important to continue to reduce debt to safer levels and rebuild fiscal buffers", the fund said.

Yet, with joblessness still high in many of the leading economies, the IMF cautioned governments against excessive spending cuts and debt reduction that would impact growth and job-creation activities.

"Hesitant recovery and persistent risks of lowflation and reform fatigue call for fiscal policy that carefully balances support for growth and employment creation with fiscal sustainability," the fund said.

While it stressed each country's situation is different, the fund added that in areas where the jobs market is stifled by regulations — an issue that arose in the IMF-supported rescue of Greece — a "transitory" loosening of government spending policy can buy time to implement labour market reforms.

In addition, governments can better target their spending to address labour market challenges, such as high youth unemployment and low participation by women.

"Measures targeted to specific segments of the labour force have been found to be more cost-effective than blanket ones," it indicated.

Also on Wednesday, the IMF said the world economy needs more productive investment and less in speculative assets, which in many cases are now overvalued and pose big stability risks.

Jose Vinals, the IMF's top financial counsellor, said that not enough of the easy money pumped into economies by advanced countries' central banks is going into economic activities that support growth. 

Instead, too much is going into financial risk-taking that poses challenges to global financial stability, he said, unveiling the IMF's newest assessment of financial risks in the world economy.

"More than six years after the start of the financial crisis, the global economy continues to rely heavily on accommodative monetary policies in advanced economies," Vinals indicated. "But the impact has been too limited and uneven."

The loose monetary policies of the US Federal Reserve, and central banks in Europe and Japan, have spurred some investment in activities that create jobs and spur production and consumption, Vinals acknowledged.

But too much has moved into assets and other speculation, which could backfire on growth if a sell-off is triggered.

According to Vinals, the world economy is at risk from "the buildup of certain excesses in financial risk taking." Many assets are "richly valued" and "way out of line from fundamentals."

In addition, a lot of risk capital has flowed into emerging-market economies — $4 trillion in their equities and bonds — that are more vulnerable to sharp shifts in the direction of flows.

"All of this has the potential of decompressing," Vinals said.

Two issues, he pointed out, that could turn the tide and set back growth are a rise in the tensions in the Russia-Ukraine crisis, and a poorly implemented tightening of monetary policy by the Federal Reserve (Fed).

Just beginning to "normalise" its easy-money policies of the past six years, the Fed needs to "be mindful of the repercussions for the rest of the world", Vinals cautioned.

"Shocks from advanced economies have the potential to more quickly propagate in emerging markets," he concluded.