Wednesday, November 2, 2011

Double Policy Impasse — Near Double Dip

The global economy was feared to be on the brink of another recessionary phase, pulled down not only by stalling demand and growth arising from persistently high levels of unemployment in major advanced economies, but this time precipitated by a dearth of business and consumer confidence as showing up in various confidence indexes across the globe. This crisis of confidence, as it has been termed, sparked off by sovereign debt crises and a series of rating downgrades of the US and the Euro zone countries, intensified as policy making reached an impasse on both sides of the Atlantic. Unlike the first phase of the global financial crisis when policy makers had unanimously called for expansionary policies to avert crisis, this time around there is a clear divergence in policy stance of various stakeholders and analysts leading to standoffs on critical issues like raising the ceiling on US government debt or the Greek bailout.

In mid-May US national debt approached its statutory limit of $14.29 trillion and measures were taken to stave off a default until August 2. (The US government is able to auction off new debt typically in the form of US Treasury securities in order to finance annual deficits. However, instituted with the Second Liberty Bond Act of 1917, the debt limit places an absolute cap on this borrowing, requiring congressional approval for any increase or decrease from this statutory level.) A political impasse over reduction in defense spending and tax hikes that could be biased against the wealthy and tax reforms involving fewer deductions and loopholes for both individuals and businesses held the global financial system to ransom. A legislation to raise the US sovereign debt limit by at least $2.1 trillion through the Budget Control Act of 2011, was finally enacted a day before the threatened default. The deal puts in place measures to cut the US deficit by $2.1 trillion over 10 years with initially about $100 billion reduction when the deal passes and another $1.5 trillion to be agreed upon by the end of the year; the first group of spending cuts apply progressively over the years to the discretionary programs that are approved annually, with automatic triggers for cuts if the targets are not adhered to. Adding to the financial market turmoil, in early August the US lost its highest safety or AAA credit rating, potentially further increasing funding costs for US public debt and the cost of borrowing for consumers and investors; this triggered off a slide in the US and global equity markets and this time around even emerging markets were not spared. However, strong growth figures released last week have for now pushed back fears of another recession, however concerns loom large that the austerity measures taken to avert the debt crises though beneficial for reducing government debt, are in fact debilitating for growth and employment. Unless there is a significant expansion in business and consumer confidence and in private demand in response to these measures, recessionary tendencies may only aggravate.

The end of the policy impasse on the other side of the Atlantic doesn’t seem to be in sight. Escalating concerns over sovereign debt default in the Euro zone and in particular potential losses to banks holding this debt greatly impacted global financial markets and spilled over to economic sentiments across the globe. Differences within economies undergoing adjustment and those providing support impeded achievement of any quick solution; this precipitated a loss of consumer and business confidence. An emergency three-pronged deal was finally reached last week to fix the Euro zone's debt crisis: (i) Private banks holding Greek government debt which now stands at about 144% of GDP, will accept a write-off of 50% of their returns; (ii) the main euro bailout fund - known as the European Financial Stability Facility (EFSF) - is to be boosted from the 440 billion euros set up earlier this year to 1trillion euros; (iii) around 70 European banks will be required to raise about 106 billion euros in new capital by June 2012. It is hoped that this would help shield them against losses resulting from any government defaults and protect larger economies like Italy and Spain from the market turmoil. However, the Greek PM’s unexpected decision of calling for a referendum on the bailout agreement, whereby the people of Greece would decide whether or not the packages of austerity measures needed to qualify for bailout payments would be implemented, has now shocked the global economy.

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