The financial crisis of 2008 and the ensuing economic challenges for many of the major economies have provided many lessons for those interested in political economy. While we may all be aware of the difficulties posed by a recession, what is not clear is the success of the various measures to lift a country out of the recession.
Depending on the country’s position, both monetary and fiscal measures have been used in combination. In many of the major economies, monetary policy has been expansionary: interest rates are at record lows (virtually zero) and quantitative easing (printing money) has been employed and inflation mitigation abandoned.
Implementation of a regulatory standard, Basle III, which will again increase capital ratios and liquidity guidelines, has been delayed (to 2019) as bank balance sheets have been weakened by the recession.
Strengthening bank capital ratios at this time would have resulted in freezing bank lending, at a time when many businesses need finance.
In the Eurozone, where the European Central Bank (ECB) does not have the money creation powers of a national central bank, the ECB has had to create other mechanisms and stretch existing ones to save the euro and the banking sector.
Mario Draghi, the head of the ECB has had to talk markets up by promising to do “whatever it takes”. In the United States, the Federal Reserve, whose mandate is the control of the money supply, has taken the unprecedented decision to buy bonds to a minimum value of US$65 billion (BDS$130 billion) a month, linking it to an unemployment target of 6.5 per cent. All this after three bouts of quantitative easing.
Countries that have had the fiscal space have run deficits. In Europe, those that have not, have had to resort to a combination of the International Monetary Fund (IMF), the European Stability Mechanism and the ECB (Italy, Spain, Greece, Portugal and Ireland), in addition to renegotiating sovereign debt where possible (Greece and Ireland).
But deficits cannot continue indefinitely and what we have begun to see is the implementation of austerity measures, by way of increased taxes, a reduction in benefits and structural reforms where necessary.
This not only includes the countries that we would expect (Portugal, Spain, Ireland, Greece and Italy) but other economies that one would have considered stronger (Germany, France, England and the United States).
Deficits are not bad in themselves.
The more difficult issue is how to deal with structural deficits which are defined as deficits that result from a fundamental imbalance between government receipts and expenditures (the Caribbean problem), as opposed to one based on one-off or short-term factors. Structural deficits will eventually pose a problem for any government.
Deficits are financed by borrowing, and continued borrowing leads to an accumulation of debt. The ability to pay off this debt is measured by a country’s debt relative to its gross domestic product (GDP), referred to as its debt-to-GDP ratio.
Therefore a rising debt to GDP ratio has negative implications. The threshold used is normally 70 per cent. The ratio for Barbados is in excess of 100 per cent which explains why the country’s credit rating has been reduced to below investment grade.
The point at which a structural deficit and a rising debt-to-GDP ratio can lead to a crisis of confidence depends on the credibility of a country.
A country with a long history of not defaulting on its debt will endure large deficits without a financial crisis. However, deficits, large or small, in themselves will not lead to a decline in economic growth. Rather it is the austerity measures to correct the deficit that lead to economic decline.
Austerity measures have been undertaken in much of the Eurozone and have led to a recession this year. England’s austerity measures have led to a “triple dip recession” as growth has not taken place.
In the United States, the mini deal done on January 1 has postponed the next crisis to March 1, 15 and 27, when the current budget expires, the debt ceiling limit is breached (and congressional approval to borrow runs out) and the automatic expenditure cuts are triggered.
To deal with one problem is challenging enough; to deal with all three together in the face of a rudderless, rebellious Republican party creates the prospect of a perfect storm. A recession is on the cards. Administrations everywhere are muddling through.
In Barbados, the administration is attempting to wait it out. And the public discussion/sensitization on the key policy measures to address the structural deficit are overdue. We cannot simply wait.
A credible medium term approach is outstanding. Both parties need to put meaningful, realistic, plans on the table in the run up to the election.
• Mariano Browne is a former minister of finance in Trinidad and Tobago and senior executive in Barbados.
