Published in Editorial Page of Financial Times, 4 December 2008
Letter to the Editor
Professor Roubini’s fairly grim assessment of the 2009 global economic outlook (“How to avoid the horrors of ‘stag-deflation’”, 3 December) is a detailed analysis of why the horrors are, in fact, unavoidable. It is consistent with his unremittingly pessimistic views not only about the depth of the crisis, but also about the ineffectiveness of policy to mitigate its aftereffects. He speaks with considerable credibility on these issues, having anticipated the deleterious impact of the bursting of the U.S. housing bubble on the financial markets and the real economy. While he may well be right, I would like to suggest that, in fact, we do not know whether 2009 will not witness the beginnings of a recovery, in response to an unprecedented combination of looser monetary policies, fiscal stimuli and the whole battery of government-sponsored interventions which have taken place over the recent past and are likely in the pipeline.
While the present crisis is of a totally different scale when compared with previous episodes of financial market turmoil, it is the case—as argued by the IMF—that during the US stock market crash of 1987, the Russian crisis of 1998 and the associated collapse of Long Term Capital Management, the technology crash of 2000, and the aftermath of 9/11, the near term outlook was also grim. All of them involved a sudden increase in uncertainty and created conditions where policymakers and markets found it difficult to assess risks. All of these episodes were characterized by increased market volatility and a flight to safer assets. But, with some lags, it soon became evident that the world was not coming to an end. Output growth in the U.S. picked up after 1987 and 1998 and was largely unaffected by the events of 9/11. The bursting of the technology bubble in 2000 was followed by a short recession.
The main danger we face is not, as professor Roubini suggests, that “in the next few months, the flow of macroeconomic and earnings news will be much worse than expected” (!) but rather that by late 2009 the global economy will be perking up again (because the housing sectors will have bottomed and the unwinding of commodity prices will boost consumption among oil importers) and governments will go back to business as usual, missing a once-in-a-life-time opportunity to address the serious vulnerabilities in the world’s financial system which the current crisis has revealed. In that scenario, the next crisis would find us with little ammunition left. That is the real danger.