After the financial and banking crisis of 2007/2008, the year of 2010 will certainly be dominated by the following global macroeconomic themes:
a) the growing importance in the world economy of Brazil, Russia, India and China – the so-called BRIC countries – with excellent perspectives, as far as their impact on world economic growth is concerned;
b) the dangerous fiscal and/or balance-of-payments situation of Portugal, Ireland, Italy, Greece and Spain – the so-called PIIGS countries – bringing serious risks for the world economy, including a renewed credit crunch;
c) the contradictory economic policies of the G-5 “big” economies ( US, UK, Germany, Japan and France).
Our purpose here is precisely to try to comment on what should be the final consequences of such a diversified and complex world economic situation in 2010, which is clearly the result of different economic policy responses undertaken by different countries (including countries which have the same currency, meaning the euro) in the last two years, as a consequence of the major world economic and financial shock of 2007/2008.
In many respects, it seems that BRICs, PIIGS and the G-5 countries are facing the same economic dillemas of the thirties after the 1929 great crash. In other words, decisions about monetary and/or fiscal policy since 2008 were quite different in each country and this will certainly happen again in 2010. Independently of their exchange rate regime, countries have demonstrated different opinions about the costs of inflation versus unemployment, as well as about how to deal with such costs and dillemas more or less effectively.
Another point to keep in mind is that public debt and monetary expansion problems are not a monopoly of the PIIGS: perhaps with one exception (Germany), all the other 13 countries listed above will have to deal with monetary and fiscal policy decisions in 2010 taking this fact into consideration, that is, high public debt ratios and excessive money growth, and the consequent limitations for the future brought about by this “new” fiscal and monetary reality of laxness created in the last few years.
Therefore, the major story of 2010 is that, for different reasons or for the same reasons, BRICS, PIIGS and the G-5 are almost being forced to adopt restrictive monetary and fiscal policies in 2010. This means higher interest rates all over the world, severe cuts in government spending, higher taxation and eventually negative growth in monetary aggregates.
Just selecting a few examples from each group – Brazil, Greece and the United States are reaching that specific moment when it becomes impossible to postpone interest rate raises. The fear of inflation begins to overcome and surpass the fear of unemployment. To make things worse, it is well known that at some point raising nominal interest rates begins to provide negative signals for inflation expectations as well as public debtors. In many aspects, looking back to the last few decades of the last century, we might be going back to risks of stagflation just like in the late seventies and early eighties. Even countries with expected high rates of economic growth in 2010, such as Brazil and China, will certainly be affected by this new world economic shock and be provoked by restrictive economic policies.
It is clear by now that governments learned the lessons of the twenties and the thirties and know the necessary instruments to avoid depression or hyperinflation. But at the same time, in contrast to some optimistic beliefs held in the last two decades (1993-2007), governments still have great difficulties in managing the inflation-unemployment dilemma under less extreme situations, which very often leads to stop and go policies.
One should not be optimistic about the present macroeconomic policy mix in many countries. Brazil is seriously facing the risk of throwing away many pillars of the last 15 years of good stabilization measures. China has an unsustainable situation as far as growth is concerned, including many bubbles, very similar to Japan before 1990. The European situation is dramatic, to the extent that Greeks and Germans should never be part of the same Monetary Union without being one single country. Any solution for Europe will represent a major retrocess, with a probable return to n currencies and possibly the end of the euro (the ones who are betting against the euro face the risk of discovering that such currency might simply disappear at the end of the day). The United States has to begin a period of restrictive fiscal and monetary measures even under a situation of 10% unemployment.
It took almost 10 years to adjust the world economy after the Great Depression of 1929. It took more than 20 years to reorganize the world economy after the Great Inflation started in the late sixties of the last century. All this suggests that perhaps we will have to wait a few more years of trials and errors, stop and go policies, before we might go back to something that would look again like the Great Moderation of 1993-2007, without major cyclical swings in the world economy. One thing is certain – 2010 will be another year of living dangerously.