Mike Callaghan is Director of the Lowy Institute's G20 Studies Centre.
When G20 finance ministers meet in Washington, DC at the IMF Annual Meetings on 10-11 October, there will much to discuss and worry about. A glance at the headlines identifies many of the issues that should be on their minds.
The financial press is currently focused on the shutdown in the US government. Hopefully, by the time ministers meet, common sense will have prevailed in the US Congress. But as global financial markets retreat due to concerns about the US government shutdown and the looming battle over the US debt ceiling, it is a reminder of the inter-connected world in which we live.
As the Washington Post reported, ‘A prolonged government shutdown – followed by a potential default on the federal debt – would have economic ripple effects far beyond Washington, upending financial markets, sending the unemployment rate higher and slowing already tepid growth.’
A chapter in the IMF’s forthcoming World Economic Outlook report, called Dancing Together? Spillovers, Common Shocks, and the Role of Financial and Trade Linkages, provides a timely backdrop for ministers when they contemplate the implications of recent developments, particularly in the US. For example, the IMF points out that the global financial crisis triggered lock-step movements from the world's economies, with growth rates at their most synchronised since the end of World War II. And as the Fund goes on to note, when a crisis occurs in a global financial hub like the US, the effects on global output are disproportionately large. [fold]
Hence all G20 ministers should worry about the brinkmanship being played out between US politicians, the fourth such ‘crisis' in the past two years. Hopefully, those involved will recognise the implications of not getting an agreement on the budget and debt ceiling and sanity will win the day, although the most likely result will be a short-term fix.
Brinkmanship over US fiscal policy will probably continue until the end of President Obama’s term in January 2017. Not only is this bad for confidence and a reason for business to delay long-term commitments, there remains the threat of ‘political miscalculation’, which would result in investors acting on concern that the US will default on its debt.
The other concern is the US Federal Reserve’s handling of its tapering from ‘quantitative easing’ (QE), part of the global macro experiment the world is experiencing. Global financial markets were rocked when the US Fed Chairman Ben Bernanke failed to announce a widely anticipated reduction in the pace of monthly purchase of US securities. In May 2013, Bernanke had appeared to be conditioning markets into accepting that the Fed was about to taper.
Among the reasons cited for an apparent shift in the US Fed’s actions was a concern over how rapidly long-term rates had risen in response to Bernanke's comments in May, and concern that the US economy was slowing and would be further handicapped by the debate over the debt ceiling.
Pierre Siklos concludes that fiscal dominance is back, in that the boundary between monetary policy and government debt management has become blurred and central banks now have to reluctantly follow the demands of fiscal policy. G20 central banks should have this squarely on their minds, for as Siklos says: ‘Low interest rates and quantitative easing may well have helped to soften the blow of the last financial crisis but policies to deal with excessive sovereign debts and the cumulative distortionary effects of ultra-low interest rates may well require more unpleasant policies in the future.’
Maintaining ultra-low interest rates for an extended period is a concern but, as the IMF warns, so is a normalisation of US interest rates at a pace that is faster than warranted by economic conditions. As the Fund notes, a rise in US interest rates will have its biggest effect in Latin America, but will also have significant effects on Asia and Europe. The world should worry about the tightrope the Fed is walking in its handling of QE tapering.
Emerging markets have been vocal regarding the impact of the ‘Fed taper’ on their economies. The Singaporean Finance Minister (and IMFC chair) Tharman Shanmugaratnam, claims that the emerging world is doomed to capital-flow instability unless the Fed takes into account financial volatility in high growth regions. He says that on the basis of self-interest, the Fed should factor in the negative feedback loop from its policies, because ‘the world is becoming more interconnected and aggregate demand from emerging markets increasingly matters for the US.’ However, Bernanke has made it clear that the Fed will be focusing on US employment and inflation.
Finally, G20 finance ministers should still worry about developments in Europe, particularly the political crisis in Italy, which has the potential to reverberate throughout the eurozone.
Bottom line: it remains a worrying time to be a finance minister (treasurer, in Australia’s case) or a central bank governor.