HOW TO AVOID A DOUBLE DIP / THE ECONOMIST ( A MUST READ )

The West’s economy

How to avoid a double dip

Rich countries need to squeeze their economies less hard and get serious about growth

Aug 27th 2011
from the print edition

ANYONE who managed to switch off during the summer holiday has faced a rude shock on his return. The world economy is in much worse shape than it was only a few weeks ago. Growth has slowed sharply in both America and Europe. Even the emerging world has lost some of its sizzle. Global share prices have dropped by around 15% since early July. Consumer confidence has slumped.
.

All this has led to a grim, and sudden, reassessment of growth prospects, especially in the rich world. Forecasts for 2012 have been slashed. The odds of a double-dip recession have risen sharply on both sides of the Atlantic.

In 2008 the world economy was saved from depression by a bold and co-ordinated plan to shore up banks and counter the slump with fiscal and monetary stimulus. Today there is no boldness (the euro-zone crisis is the epitome of politicians doing too little too late). There is no co-ordination. And, to the extent that policies have a common theme, it is the wrong one: politicians across the rich world are taking too short-term a view of fiscal austerity—a bout of budget-cutting which will only increase the risk of another recession.


Wanted: a growth agenda


It does not have to be this way. Echoing the spirit of 2008, policymakers could adopt a co-ordinated strategy to boost growth. Two priorities stand out. First, a recalibration of fiscal and (in some places) monetary policy. Second, a big push on supply-side reforms, from freeing trade to slashing red tape.


Adjusting fiscal policy does not mean simply doling out more stimulus. The trick is to put in place more reforms now that will improve the public finances over time without slamming too hard on the brakes today.


America is in most need of such a shift. It has done virtually nothing to deal with its medium-term deficit, but on current policy will see the biggest short-term tightening of the big rich economies next year. That would have been a poor choice even in a reasonable recovery. Given the economy’s weakness, it looks daft. But it could be fixed. The congressional supercommittee charged with finding ways to trim the ten-year deficit as part of the recent debt-ceiling deal could agree on a bolder package of entitlement cuts and new revenue, while Barack Obama and the Republicans could limit the short-term squeeze by extending the temporary payroll-tax cut and boosting spending on things like roads and school repairs.


Europe’s fiscal policy also needs recalibrating. Britain, which is reducing its fiscal vulnerability with a well-designed austerity plan, can probably afford to tweak the pace of tightening next year—not by abandoning the spending cuts but by cushioning them with tax incentives to invest. Crisis-hit countries in the euro zone, under pressure from Germany and the bond markets, are now trying to shrink deficits as fast as possible. But a lesson from Italy and Spain is that bond markets worry as much about economies’ ability to grow as the size of their deficit. That suggests putting priority on fiscal reforms that boost growth, such as raising the retirement age. And it argues against speed at all costs. Greece will benefit far more from a well-designed privatisation scheme than a fire-sale to raise cash.


The euro zone also needs a monetary-policy shift. The European Central Bank is in the peculiar position of both holding the single currency together (through its purchase of Italian and Spanish bonds) and at the same time making those countries’ adjustments harder by raising short-term interest rates. That is a nonsense. The ECB should give its overindebted members room to adjust. At a time of fiscal austerity, even of a more calibrated sort, monetary looseness is essential—as the Bank of England has admirably shown.

One way of achieving this without squandering years of credibility might be for central banks to pay greater attention to the path of nominal GDP, rather than just inflation. This is likely to mean tolerating occasional bursts of rising prices.


A serious growth agenda should also involve a joint commitment to productivity-boosting reforms.

Measures such as cutting trade barriers or getting rid of excessive regulation (for which the Obama administration announced plans this week) are a good idea everywhere. Other priorities will differ by country. America needs to overhaul its worker-training programmes, while many European countries should open up cosseted professions and relax planning rules. The OECD, a rich-country think-tank, which measures these “structural rigidities”, could co-ordinate an effort to reduce them.


Such a growth agenda won’t transform the rich world’s prospects. The recovery will still be fragile and sluggish. But it has a far better shot at avoiding both recession and stagnation than today’s policy mix. It is high time to change course.