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The sixth G20 Summit was held at Cannes (November 3-4, 2011) in difficult circumstances. The tepid global recovery was grinding to a halt, and there was renewed instability in financial markets emanating from sovereign debt concerns, especially – but not exclusively – in the euro zone periphery.
Just before the summit, I had written in these columns that, in these circumstances, the Cannes summit might be compared to the “trillion dollar” London summit (“It’s a long road from Keynes to Cannes”, October 30, 2011). Also, since policy makers went into the summit with empty pockets and depleted policy instruments, unlike in London, the intellectual battle over policy would be between the Keynesian and rational expectation schools.
A quick glance at the Cannes Declaration would reveal that despite the inability to put any numbers on the table, Keynes seems to have won hands down.
The market’s response to the outcome at Cannes was not kind: several euro zone sovereign bonds have been going into free fall ever since, as the contagion spreads rapidly from the periphery of the euro zone to the core and beyond. This may have dented G20’s image as the premier multilateral forum for international policy co-operation and crisis management. Why should this have been the case? It is possible that the market deconstructed the Cannes Communiqué as outlined in the stylised subtext below?
“We have reached agreement on a number of ongoing G20 issues. However, we don’t have a fix on the two big ‘crisis’ issues of the euro zone and faltering private demand. Even though the euro zone problem is of systemic importance, and will affect us all, it is too big for us to handle. It is for the Europeans to find a solution. We can help by further enhancing IMF’s resources, but are not in a position to commit anything.”
“At London we agreed to collectively commit one trillion dollars to international organisations, and to using fiscal and monetary policies to the hilt, to deal with the greatest threat to the global economy since the Great Depression. At Cannes, where we face a similar situation, we are not in a position to commit more resources to international organisations, but instead commit to country-specific short-term and long-term actions to address concerns regarding growth and sustainability. These commitments are enshrined in our Cannes Action Plan, the piece de resistance of our Communiqué, which is an aggregation of existing national budgets and plans.”
“We remain committed to fiscal consolidation, but now is not the time (recall St Augustine’s medium to long-term commitment to chastity), because there can be no fiscal consolidation in the absence of growth. Through our Action Plan we will continue with short-term macro-economic stimulus, despite the spiking debt/GDP ratios that markets are concerned about, as long as growth is below our expectations (which may be unrealistic, based as they are on unsustainable pre-crisis levels), and until we are disciplined by markets (Greece, Portugal, Ireland, Italy, etc), at which point we shall turn to non-commercial sources (countries with deep pockets such as Germany, China, oil-rich countries, the IMF) so that we can carry on at least till the next elections. However, if market pressures continue to remain overwhelming, we are prepared to adjust sharply straightaway, even if demand does not bounce back (Europe). Wherever possible, and to the extent possible, in such cases we will shift the burden of stimulus to central banks, even though we are unsure that monetary policy transmissions are working well. We will continue with quantitative easing (QE) to support/replace fiscal policy, especially since inflation is not an issue and our findings show that QE does not spill over to inflate commodity prices and EMEs. Inflation in the latter is a supply-side issue that they need to address themselves.”
“We are very concerned about persistently high levels of employment. Therefore, while conventional wisdom suggests that greater flexibility in labour markets stimulates investment, our growth strategy will be employment-led and not the other way around. We also encourage all countries to put in place the social protection schemes that we can no longer afford.”
This stylised subtext suggests that markets may have felt that the G20 is fixated on short-term growth that pleases electorates (the Keynesian worldview that in the long-term we are famously dead is at heart a very political statement), while they were focused on medium- to long-term sustainability of public finances. This paradox, which lies at the heart of capitalist democracies, is more apparent than real. This is because if markets do not step up to the plate, the burden eventually falls on the taxpayer, who is also the elector.
What alternative messages could markets and investors have been looking for from Cannes from a rational expectations perspective?
First, they could have been expecting some introspection regarding the aggressive Keynesian response at London to what was, in essence, not a cyclical but a balance-sheet recession, especially since it does not seem to have worked as expected.
Second, they may have hoped for more pointed recognition that public debt in advanced countries is already too high given a realistic outlook for long-term growth, factoring in the long-lasting downward pressure from balance-sheet recessions, ageing and uncertainty over the pace of global demand rebalancing. They might have expected a candid acknowledgement that more leverage cannot resolve a problem of excessive leverage, and that shifting leverage from private to public and, finally, to central bank balance sheets was no solution. This would have meant that there was no getting away from short-term adjustment (especially since the long-term is an aggregation of short-terms) and pain (structural reforms to improve efficiency and competitiveness) that would put growth and public finances on a sustainable footing going forward, even if this came at the cost of sacrificing some short-term growth. The bottom line is: an acknowledgement that there is life beyond the present and that the long term matters.
Third, while assurance was no doubt needed that social safety nets would be in place to cushion persistently high levels of unemployment, they may have expected a clearer message on the interplay between growth and jobs that could have made rebalancing from public to private demand, and consequently fiscal consolidation, easier.
Fourth, on the euro zone, markets may have expected an acknowledgement that there was a structural flaw – monetary union without a fiscal union – that needed to be fixed quickly.
The writer is a civil servant. These views are personal