Despite this week's interest-rate cuts, the economic outlook remains murky
Sep 20th 2001
IN THE immediate wake of the assault on America, it seemed positively callous to think about its economic impact. But as America celebrated the triumphantly smooth reopening of its stockmarkets this week, bad economic news could no longer be ignored. The world's central banks, led by the Federal Reserve, tried a pre-emptive move by making the first co-ordinated series of interest-rate cuts since the 1987 stockmarket crash. But the markets were right not to be much impressed, and to mark prices down sharply .
This is not because the attacks will themselves have such dire economic effects. The trouble is that they came at such a fragile moment for the American and world economies. The University of Michigan survey, taken before the attacks but published afterwards, showed American consumer confidence at its lowest level for eight years. And that was just one of a raft of recent indicators suggesting that the American economy was heading into recession even before September 11th. Now consumer confidence is likely to slip further. And the news beyond America is also bad. Indeed, since the world's economies are unusually synchronised at present, the sharp slowdown in America means that the global economy is on the verge of its first recession since 1990.
To the rescue?
What should governments and central banks do? This week's interest-rate cuts were sensible and even, in the case of Europe, overdue. So was the belated conversion to monetary relaxation by the Bank of Japan, though it needs to do more still. Over the next few weeks, more monetary easing is likely to be needed. Yet, although the full impact of the Fed's interest-rate cuts so far this year has still not been felt, looser monetary policy alone is unlikely to be enough to fend off recession. Unlike previous recessions since the second world war, which were mostly demand-led, this one reflects a credit and investment bust that will take longer to work through the system.
If monetary easing by central banks will not be enough, that puts more of a burden on governments. Fiscal policy, in particular, should be used to cushion the impact of recession. Fortunately, in both Europe and America, inflationary pressures are extremely low and public finances are healthy. Now is not the time to heed hair-shirt philosophies that might artificially constrain fiscal policy, such as Europe's “stability pact” or America's Social Security “lock-box”. With the risks to the world economy so clearly on the downside, it would be better for most governments to err on the side of too much fiscal stimulus than too little. The gloomy outlook also makes it even more important that governments should nourish the free trade that has been at the heart of post-war growth: the need for a new trade round to be launched in Doha in November is more pressing than ever.
The other big issue for governments to think through is whether, and how far, they should come to the rescue of industries and businesses that are suffering in the aftermath of the terrorist attacks. This is most acute for the airlines, for which the American government is preparing a large aid package (see article). But other businesses, from hotels to aerospace to insurance, may be next in line to seek help.
In a few specific cases, notably the airlines, there is a case for temporary, well-directed public subsidy. America cannot afford to let several of its big airlines go under simultaneously, for the effect on jobs and confidence could be too great. The government should compensate the carriers for the time when they were grounded, and it should also take on the burden of paying for tighter security at airports. But there is a danger in too much indiscriminate support: it would freeze the airlines in their present form, with their current capacity, and reduce competition, at a time when the right response is probably to shrink the industry. It would be better to allow most airlines to go into chapter 11 bankruptcy than to use subsidies to keep some of them out of it. If the number and size of airlines in America and Europe needs to be cut, governments should not prevent that from happening.
A similar message holds elsewhere. Ahead of the reopening of the stockmarkets, for instance, regulators relaxed several rules on such things as share buybacks, in the hope of propping up share prices. But stockmarkets need to fall, not just to reflect the prospect of recession but also to correct their previous overvaluation. More generally, the American and world economies are suffering from overcapacity. Although governments should soften the pain of recession so far as they can by expanding demand, market forces are the best way to eliminate excesses in supply. They are also the best response to an attack that was, in one sense, aimed at the free-market system itself
Sep 20th 2001
IN THE immediate wake of the assault on America, it seemed positively callous to think about its economic impact. But as America celebrated the triumphantly smooth reopening of its stockmarkets this week, bad economic news could no longer be ignored. The world's central banks, led by the Federal Reserve, tried a pre-emptive move by making the first co-ordinated series of interest-rate cuts since the 1987 stockmarket crash. But the markets were right not to be much impressed, and to mark prices down sharply .
This is not because the attacks will themselves have such dire economic effects. The trouble is that they came at such a fragile moment for the American and world economies. The University of Michigan survey, taken before the attacks but published afterwards, showed American consumer confidence at its lowest level for eight years. And that was just one of a raft of recent indicators suggesting that the American economy was heading into recession even before September 11th. Now consumer confidence is likely to slip further. And the news beyond America is also bad. Indeed, since the world's economies are unusually synchronised at present, the sharp slowdown in America means that the global economy is on the verge of its first recession since 1990.
To the rescue?
What should governments and central banks do? This week's interest-rate cuts were sensible and even, in the case of Europe, overdue. So was the belated conversion to monetary relaxation by the Bank of Japan, though it needs to do more still. Over the next few weeks, more monetary easing is likely to be needed. Yet, although the full impact of the Fed's interest-rate cuts so far this year has still not been felt, looser monetary policy alone is unlikely to be enough to fend off recession. Unlike previous recessions since the second world war, which were mostly demand-led, this one reflects a credit and investment bust that will take longer to work through the system.
If monetary easing by central banks will not be enough, that puts more of a burden on governments. Fiscal policy, in particular, should be used to cushion the impact of recession. Fortunately, in both Europe and America, inflationary pressures are extremely low and public finances are healthy. Now is not the time to heed hair-shirt philosophies that might artificially constrain fiscal policy, such as Europe's “stability pact” or America's Social Security “lock-box”. With the risks to the world economy so clearly on the downside, it would be better for most governments to err on the side of too much fiscal stimulus than too little. The gloomy outlook also makes it even more important that governments should nourish the free trade that has been at the heart of post-war growth: the need for a new trade round to be launched in Doha in November is more pressing than ever.
The other big issue for governments to think through is whether, and how far, they should come to the rescue of industries and businesses that are suffering in the aftermath of the terrorist attacks. This is most acute for the airlines, for which the American government is preparing a large aid package (see article). But other businesses, from hotels to aerospace to insurance, may be next in line to seek help.
In a few specific cases, notably the airlines, there is a case for temporary, well-directed public subsidy. America cannot afford to let several of its big airlines go under simultaneously, for the effect on jobs and confidence could be too great. The government should compensate the carriers for the time when they were grounded, and it should also take on the burden of paying for tighter security at airports. But there is a danger in too much indiscriminate support: it would freeze the airlines in their present form, with their current capacity, and reduce competition, at a time when the right response is probably to shrink the industry. It would be better to allow most airlines to go into chapter 11 bankruptcy than to use subsidies to keep some of them out of it. If the number and size of airlines in America and Europe needs to be cut, governments should not prevent that from happening.
A similar message holds elsewhere. Ahead of the reopening of the stockmarkets, for instance, regulators relaxed several rules on such things as share buybacks, in the hope of propping up share prices. But stockmarkets need to fall, not just to reflect the prospect of recession but also to correct their previous overvaluation. More generally, the American and world economies are suffering from overcapacity. Although governments should soften the pain of recession so far as they can by expanding demand, market forces are the best way to eliminate excesses in supply. They are also the best response to an attack that was, in one sense, aimed at the free-market system itself
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