Guest column: Seven steps to avoid double dip recession

Humor Unplugged’s economic adviser Chris Aethelburh on how to prevent a double dip recession.

Chris Aethelburh

There seems to be an ongoing debate about when to start a second set of stimulus to prevent a double dip recession. Germany and the European Central Bank are already pushing aggressively for fiscal austerity while US is planning fiscal consolidation pending political approval.

So should policymakers travel down the stimulus path again or should they revisit other ways to prevent another recession? If monetary and fiscal stimulus is injected without a corresponding rise in consumer demand, there is a risk of deflation. Fiscal austerity to certain degree is necessary in countries facing large debt, but raising taxes and cutting government spending may infact make the recession and deflation worse.

But, if policymakers manage stimulus for too long, a sovereign debt crisis may loom large on the horizon. If stimulus exerts further strain on the treasury, interest rates may go up and choke economic recovery and GDP growth. The US and other deficit countries – including the United Kingdom, Spain, Greece, Portugal, Ireland, Iceland, Dubai, and Australia – have all been spending more than their income and running current-account deficits. While, emerging Asian economies – particularly China and a few other countries have been maintaining a tight leash on spending. But these trends may change soon.

Overspending countries are now pulling back and curbing imports to reduce their external deficits and deleverage. However if the debt nations spend less while surplus ones don’t not move in to compensate the slump, excess production will result leading to more supply and less demand.

Viable credit consolidation is
essential

So what can policymakers do? In countries where early fiscal austerity is necessary to prevent a fiscal crisis, monetary policy should be much easier – which means lower policy rates and more quantitative easing – to make up for recessionary and deflationary effects of fiscal tightening. In general, near-zero policy rates have to be maintained in most advanced economies to support the economic recovery.

Second, countries where bond-market goons have not yet awakened (like the US and the UK) should maintain their fiscal stimulus while designing credible fiscal consolidation plans.

Third, over-saving countries should implement policies that reduce their savings (yes I mean it) and current-account surpluses. These countries should implement reforms that reduce the need for precautionary savings and let their currencies appreciate. Germany needs to maintain its fiscal stimulus and work on improving domestic demand. Emerging countries should also try and ease market curbs to allow deficit countries to sell more in these markets.

Fourth, countries with current-account surpluses (especially China) should let their currencies appreciate. The European Union should work towards stabilising the Euro around rates that will help weaker economies like Greece and Portugal recover.

Fifth, in countries where private-sector deleveraging is very rapid via a fall in private consumption and private investment, the fiscal stimulus should be sustained and extended.

Sixth, while regulatory reform that increases the liquidity and eases capital ratios for financial institutions is necessary. Countries like India need to ease credit curbs to allow liquidity and target inflation by curbing public spending and place a cap on salary for government employees.

Seventh, in countries where private and public debt levels are unsustainable – household debt in countries where the housing boom has gone bust and debts of governments, like Greece’s, that suffer from insolvency rather than just illiquidity – liabilities should be restructured to prevent severe debt deflation and seizure of spending.

Finally, the IMF and EU should intervene appropriately to help severe deflationary recession in countries that need private and public deleveraging.