Menzie Chinn is Economics Professor of Public Affairs and Economics at the University of Wisconsin, Madison.
What obstacles do you see right now to avoid another lost decade?
The main obstacles are political, both within countries, and between. Obviously, in terms of inter-country differences (and deferring for the moment the Euro area issue), we can see policymakers striving to reallocate aggregate demand toward their own economies via exchange rate management, hindering the reduction of global imbalances.
Within countries, deeply entrenched interests stymie much needed medium to long term fiscal adjustment, particularly in the United States. The wealthy object to higher tax rates, and the long term challenge of rising government-paid health care costs in the US remains only partly addressed.
Finally, we are only seeing halting movement toward greater regulation of the financial sector, making the world economy vulnerable to another global financial crisis. While there are promising moves toward higher capital requirements for international banks, other measures have been delayed in the US.
Do the modern Central Banks have the tools and the skill to tackle a severe crisis which depresses revenues?
Modern central banks have the tools to mitigate severe crises, but they cannot on their own deal with a crisis and recession of the magnitude we have just experienced. When interest rates hit the lower interest rate bound, central banks can provide liquidity as the lender of last resort, thus preventing complete financial collapse. In addition, the central bank can also commit to keeping interest rates low, thereby depressing expected future real interest rates to spur the economy. But in the end, fiscal policy has to be used. And there remains the issue of whether the political constraints prevent effective central bank action.
Europe faces serious economic and political challenges. What is to be done to avoid a disaster? Is the fiscal austerity the right response?
Europe faces a primarily political problem. It’s clear that trying to re-establish country solvency purely by austerity measures is not feasible, politically. Furthermore, reductions in spending will not make much progress if they throw economies into recession – an effect magnified when many of the tightly linked euro area countries undertake contractionary measures simultaneously. So, it’s clear that a program that writes down debts, recapitalizes the banks, and where the ECB moves toward a more expansionary stance is required (that is, for the duration of the crisis, the ECB needs to target a higher inflation rate). However, the first two requires that certain groups take losses, and bear a greater financial burden. And that is never a popular option.
Thank you very much.
Menzie Chinn is Economics Professor of Public Affairs and Economics at the University of Wisconsin, Madison. His current book with Jeffry Frieden is The Lost Decades: The Making of America’s Debt Crisis and the Long Recovery, (W.W.Norton).