Blanchard: How to Emerge from the Crisis in 2009

Olivier Blanchard, chief economist of the IMF, says that if the right policies are followed, it’s possible to begin emerging from the crisis before the end of 2009:

How to emerge from the crisis in 2009, by Olivier Blanchard, Project Syndicate: …Let me first set the scene by making three observations on where we are today. First, in the advanced countries, we have probably seen the worst of the financial crisis. There are still land mines,… but the worst days … are probably over.

Second, and unfortunately, the financial crisis has moved to emerging countries. In crossing borders, the sharp portfolio reallocations and the rush to safer assets are creating not only financial but also exchange-rate crises. Add to this the drop in output in advanced countries, and you can see how emerging countries now suffer from both higher credit costs and decreased export demand.

Third, in the advanced economies, the hit to wealth, and even more so the specter of another Great Depression, has led people and firms to curtail spending sharply… The result has been a sharp drop in output and employment, reinforcing fears about the future, and further decreasing spending.

Let me now turn to policy. If my characterization of events is correct, then the right set of policies is straightforward:

First, the measures put in place earlier to repair the financial system must be refined and consolidated. … Central banks generously provided liquidity. But governments soon realized that the main issue was solvency. They pledged to implement programs aimed at asset purchases…, recapitalization…, and guarantees…The basic architecture for these measures is now in place, but the implementation has been often haphazard. Lessons from previous banking crises around the world could have been learned faster. The twists and turns in some of the programs, most notably in the United States, have left markets confused, and have led private investors to stay on the sidelines, waiting for policy clarification… I have little doubt that learning by doing will eventually lead to coherent programs. But time has been lost.Second, emerging market countries must get help in adjusting to the financial crisis. … Are the proper help measures in place? Yes and no. For a few countries, the main central banks have provided access to liquidity through swap lines. The International Monetary Fund, for its part, has created a new liquidity facility…For the time being, these arrangements have been sufficient. But liquidity provision needs to be provided on a more coherent and comprehensive basis. As for countries that need more help, this is the IMF’s natural function. … One may reasonably worry that the available funds will be depleted before the crisis is over.Third, governments must counteract the sharp drop in consumption and investment demand. In the absence of strong policies, it is too easy to think of scary scenarios… It is thus essential for governments to make clear that they will do everything to eliminate this downside risk.Can they credibly do it? The answer is yes. With interest rates already low, the room for monetary policy is limited. But the room for fiscal policy is wider, so governments must do two things urgently. First, in countries in which there is fiscal space, they must announce credible fiscal expansions; we — the IMF — believe that … a global fiscal expansion about 2 percent of world GDP is both feasible and appropriate.Finally, and just as importantly, governments must indicate that, if conditions deteriorate, further fiscal expansion will be implemented. Only with such a commitment will people and firms be confident that we are not headed for a repeat of the Great Depression, and start spending again.My strong belief is that if these policies are followed, by the end of 2009, if not sooner, the world economy will start recovering from the crisis.

Originally published at the Economist’s View reproduced here with the author’s permission.

3 Responses to "Blanchard: How to Emerge from the Crisis in 2009"

  1. Guest   December 22, 2008 at 4:09 pm

    Bailout the US Economy or bailout Wall Street Banksters? Bernanke and Paulson’s perspective, any small gain by workers is regarded as “anti-free market” and tantamount to communism. The corporate mandarins would like to preserve the current antagonistic, labor-debasing system and keep workers one paycheck away from the homeless shelter. But it’s not good for the economy and it’s not good for the country. It just perpetuates the chasm between rich and poor, suggesting of a species irreconcilably divided into slave owner and chattel. The only way to overcome these differences is by narrowing the wealth gap and rewarding hard work with fair pay.Greenspan figured out how to strengthen the grip of the banking sector by creating asset bubbles. That was his contribution during the Clinton years. The leveraging of complex financial products and the surge in real estate prices gave the impression of prosperity, but it was all smoke and mirrors. The “wealth effect” vanished as soon as the interest payments on mortgages could no longer be paid. That’s when Maestro’s bubble blew up and Greenspan retired to write his memoirs.So far, world stock indexes have lost over $30 trillion and there will probably be another bloody leg-down in 2009. As the underlying economy contracts, there’s no need for a lumbering, oversized financial system. Institutions will have to be shut down and their assets will have to be sold at auction. That means prices will continue to fall, business activity will falter, and GDP will shrivel. The mismatch between output and falling demand presages a painful correction. When credit gets scarce, speculative investment can’t sufficiently lubricate the system, and a stampede for the exits begins. These are the real costs of asset bubbles; a quick descent into deflationary hell.The Fed and its Wall Street colleagues have reworked the economy in a way that diverts energy from productive activity to myriad credit-enhancing scams that create an inherently unstable financial system. Even now, with manufacturing in tatters, consumer spending at its nadir and factories hemorrhaging jobs at a Depression-era pace; Bernanke is still trying to keep the teetering banking giants propped up and out of Chapter 11. It’s a fool’s errand. The economy needs to fixed from the bottom-up not the top-down; that’s just throwing money down a rathole.

    • Anonymous   December 24, 2008 at 10:19 pm

      I think you are right on target. I just hope the sleeping public will wake up and take back their country.

  2. Gulam   December 23, 2008 at 2:04 am

    IMF is the problem itself. Nothing that comes out of IMF should be believed.Once IMF and World Bank are shut down, the emerging markets will do well.