The best recipe for avoiding a global recession.

retrieve from FT.com By Jeffrey Sachs
Published: October 27 2008 19:52 | Last updated: October 27 2008 19:52

Before our political leaders get too fancy remaking capitalism next month at the Bretton Woods II summit in Washington, they should attend to urgent business. Since the closure of Lehman Brothers triggered a global banking panic, political leaders in the US and Europe have successfully thrown a cordon round their banks to prevent financial meltdown. What they have not done yet is to co-ordinate macroeconomic policies to stop a steep global downturn. This is the urgent agenda.

A US downturn will not be avoided. US households cannot continue to spend more than their income as they have in recent years, even if the credit crunch eases. Household consumption is bound to fall steeply. The writedowns in US household wealth from the reversals in housing and equities will probably reach $15,000bn (€12,000bn, £9,700bn) and the resulting steep decline in private consumption and investment could reach about one-tenth of that amount.

Some other economies will also suffer home-grown recessions because they too allowed a housing bubble to develop, which has now burst. This appears to be the case in Australia, the UK, Ireland and perhaps Spain. This drop in spending outside the US because of capital losses and reversals in housing may add another $300bn-$500bn to first-round decline in global demand.

Yet even a steep recession in the US and in a few other countries need not throw the world into recession. The world economy is about $60,000bn, so a first-round demand decline of as much as $1,800bn would be about 3 per cent of world output. If there were no offsetting macroeconomic policy changes, the demand decline could be multiplied further to as much as 6 per cent, relative to 4 per cent trend growth, meaning a global decline of about 2 per cent.

On the other hand, even a 3 per cent global demand decline can be substantially offset by expansionary policies, undertaken by the surplus economies of Asia and the Middle East. Ironically, until recently China had been pursuing monetary and fiscal tightening to fight inflation. Now China must make a policy U-turn, to boost its internal demand and support a co-ordinated expansion throughout east Asia.

Any co-ordinated expansion should include the following actions. First, the US Federal Reserve, the European Central Bank and the Bank of Japan should extend swap lines to all main emerging markets, including Brazil, Hungary, Poland and Turkey, to prevent a drain of reserves. Second, the International Monetary Fund should extend low-conditionality loans to all countries that request it, starting with Pakistan. Third, the US and European central banks and bank regulators should work with their big banks to discourage them from abruptly withdrawing credit lines from overseas operations. Spain has a role to play with its banks in Latin America.

Fourth, China, Japan and South Korea should undertake a co-ordinated macroeconomic expansion. In China, this would mean raising spending on public housing and infrastructure. In Japan, this would mean a boost in infrastructure but also in loans to developing nations in Asia and Africa to finance projects built by Japanese and local companies. Development financing can be a powerful macroeonomic stabiliser. China, Japan and South Korea should work with other regional central banks to bolster expansionary policies backed by government-to-government loans.

Fifth, the Middle East, flush with cash, should fund investment projects in emerging markets and low-income countries. Moreover, it should keep up domestic spending despite a fall in oil prices. Indeed, the faster a global macroeconomic expansion is in place the sooner oil prices will recover.

Sixth, the US and Europe should expand export credits for low and middle-income developing countries, not only to meet their unfulfilled aid promises but also as a counter-cyclical stimulus. It would be a tragedy for big infrastructure companies to suffer when the developing world is crying out for infrastructure investment.

Finally, there is scope for expansionary fiscal policy in the US and Europe, despite large budget deficits. The US expansion should focus on infrastructure and transfers to cash-strapped state governments, not tax cuts. This package will not stop a recession in the US and parts of Europe, but could stop a recession in Asia and the developing countries. At the least it would put a floor on the global contraction that is rapidly gaining strength.

The writer is director of the Earth Institute at Columbia University and special adviser to Ban Ki-Moon, UN secretary-general.

Markets demand US action.

news retrieve from Emerging Markets - Dated 13th October 2008

The US must match the sweeping financial system rescue measures announced yesterday by European leaders and by other countries, and move immediately to unfreeze global credit markets by guaranteeing interbank lending, financial industry leaders said yesterday.

Leaders of the 15 eurozone countries, at their emergency gathering in Paris, agreed on a package of measures to prevent systemically important banks from failing and to unfreeze credit markets in a bid to halt panic.

The moves, which will be detailed today by European authorities, were matched by similar initiatives yesterday in Norway, Portugal, Australia and New Zealand as well as by Gulf states.

In Washington, financiers gathered at the IMF/World Bank meetings greeted the measures, and said the US must follow suit.

Billionaire investor George Soros told Emerging Markets the European plan is “real”, and expressed confidence that the US would follow suit. “It will work”, he told a press briefing at the IMF in Washington. “We will have similar measures in the US. Libor should return close to the Fed fund rates. That will be a significant improvement.”

Richard Fisher, president and CEO of Reserve Bank of Dallas, pledged that members of the US Federal Reserve system would “do whatever we have to do to provide a credible backstop for the credit system. Wecan and will restore order to the credit markets, but we can not undo in short order the damage to confidence.”

Markets welcomed the plan. As Emerging Markets went to press, Sydney’s and Seoul’s indexes leapt 4.5% and 2.7% respectively in early trading.

At the same time, the UK finalized its plans for injecting new capital into banks, announced earlier. Prime minister Gordon Brown said: “We will see over the coming few days worldwide action that will make people see that confidence in the banking system can be restored.”

The Paris meeting was called by French president Nicolas Sarkozy following last Friday’s G7 finance ministers’ meeting in Washington, that has been criticised for failing to offer concrete and collective solutions to the financial crisis.

Sarkozy said after the Paris meeting that a series of coordinated announcements of financial details could be expected today from leading European capitals.

According to a eurozone joint statement, leaders pledged to help or subscribe to debt-raising by banks for periods of up to five years. This should take the pressure off the blocked interbank market and also off bank balance sheets.

Germany alone is expected to unveil a rescue package for its banks worth around 400 billion euros, an official in Chancellor Angela Merkel’s conservative party said yesterday.

Financial industry leaders gathered in Washington had throughout the day been repeatedly calling for leading nations of the world to show “leadership”.

Citigroup senior vice chairman Bill Rhodes told a meeting of the Institute of International Finance, of which he is first vice chairman: “Policy makers need to get out in front. Resolving the crisis will require strong leadership and making difficult decisions.”

Deutsche Bank chief executive Josef Ackermann said: “The market is stalled now and so public policy actions to restore the market are essential,” he said, adding that “a systemic crisis needs systemic responses.”

AIG vice-chairman Jacob Frenkel told Emerging Markets that markets had interpreted the lack of concreteness in the G7 finance ministers’ statement “as a signs of lack of agreement” which served only to further undermine confidence. “What the markets are now looking for is something that is more concrete than the general statements of intent,” he said.

“We must see further initiatives within the next 24 hours and they must be coherent and concrete,” he said. “Markets are the gauge” and they are providing “a daily referendum” on policy-makers actions, Frenkel added.