Historically, market economies have exhibited an intrinsic propensity to fluctuate, sometimes with periods of more pronounced instability, including recurrent economic crises. It appears some degree of macroeconomic instability is inevitable. Some macroeconomic instability may even be desirable to the extent that development processes involve quantitative and qualitative changes in all economic and social variables, and advance at uneven paces. However, high macroeconomic instability is strongly detrimental to economic development and social welfare. Indeed, it inhibits or distorts long-term economic decisions related to productive investment, employment creation and innovation. In addition, large swings in economic activity, volatility in exchange rates and financial markets and boom-and-bust episodes entail large economic and social costs: excessive credit and misguided investment decisions during expansions generate unsustainable debt levels, leading to credit crunches, firm bankruptcies, fiscal constraints, job and income losses, and increasing poverty during recessions. The resulting losses in productive and human capacities may take a long time to be reversed, when they are not irreparable. Thus, policymakers should strive to provide a macroeconomic framework which is stable enough to encourage investment and entrepreneurship and help prevent crises; at the same time, it should be flexible enough to allow for macroeconomic adjustments and structural change.
Never think that lack of variability is stability. Don’t confuse lack of volatility with stability, ever.Nassim Nicholas Taleb
In recent decades, macroeconomic instability has significantly increased at the global level. This has been the result of the international expansion of underregulated financial market forces and the weakening of stabilizing factors, such as regulation, public investment and a sustained increase in labour incomes. The latter two factors ensured stable growth in aggregate demand in many major countries.
For developing countries, the main sources of macroeconomic instability stem from their external economic environment. These are large and volatile international capital flows and highly variable international commodity prices. The breakdown of the post-war international monetary system in the early 1970s and the open-door policy with respect to large-scale private international capital flows have meant that the provision of global liquidity is no longer determined by official sources. These have increasingly been supplemented by cross-border private operations channelled through private financial institutions. Privately created global liquidity does not respond to investment needs in developing countries, but rather depends on monetary policy decisions in developed countries (UNCTAD, 2015a). In addition, most loans are no longer used to finance trade and real investment as happened with those from official sources; instead, an increasing proportion of capital flows are of a short-term and speculative nature. Rather than supporting productivity growth, structural transformation and inclusive development, a large part of short-term capital inflows fuels consumption and asset bubbles, harms competitiveness by appreciating the currency and eventually increases volatility in domestic financial markets (UNCTAD, 2013d).
To the extent that governments also have easier access to external borrowing, openness to financial markets encourages the adoption of procyclical monetary and fiscal policies that increases macroeconomic instability and leads to the accumulation of risky balance sheets. When they eventually happen, sudden capital reversals trigger very costly financial, fiscal and balance-of-payments crises.
The other main external factor affecting macroeconomic stability in developing countries is the volatility in commodity prices. Large cyclical variations in those prices are not new at all. In the case of hydrocarbons and mining products, low price elasticityPrice elasticity of demand is a measure of the relationship between a change in the quantity demanded of a particular good and a change in its price.
more on the demand side and delays in adjusting their production capacities on the supply side explain the succession of rather long periods of undersupply followed by periods of oversupply in these commodity markets (unless some producers manage to regulate supply, for example, the Organization of the Petroleum Exporting Countries). For agricultural products, prices are strongly influenced by unpredictable weather conditions. This historical tendency to price volatility has been exacerbated with the financialization of commodity markets, as commodities have been increasingly used as an alternative asset class to optimize the risk return profile of financial portfolios. This makes commodity prices vulnerable to changes in asset allocation decisions (UNCTAD, 2009; UNCTAD, 2011a).
Sustained and inclusive development requires policies to enhance macroeconomic stability and reduce vulnerability to external shocks. The global economy lacks the appropriate tools for taming these destabilizing forces and mitigating their negative impacts; on the contrary, international monetary and financial governance has significant procyclical and recessionary biases. These problems are patent in the lack of effective prudential regulation to limit instability and prevent crises, as well as the unbalanced and unfair mechanisms to deal with crises when they occur.
Regarding financial regulation, global mechanisms for discouraging or managing short-term capital movements, such as a
Tobin taxAn excise tax assessed on currency conversions. The tax is imposed to help stabilize currency and interest rates by penalizing currency speculation. (See Goal 10 target 10.5), are lacking. Most of the burden to deal with these flows is left to recipient countries, which usually have difficulties in enforcing capital controls. A better prudential regulation through supervision in countries where flows originate could help discourage such speculative flows. Rules to regulate international banks (adopted by the Bank for International Settlements) also introduce a procyclical bias as they establish risk-weighted capital requirements. As perceived risks are low during expansions, the rules allow for high leverage and increased loans, which boost growth and feed bubbles. Conversely, with soaring risks during recessions, rules push to stiff deleveraging, aggravating economic recession and leading to widespread bankruptcies. These rules should be reformed in a way that favours countercyclical credit policies and helps channel credit to productive uses, particularly long-term investment.
When unsustainable external imbalances push some countries to request financial assistance from multilateral institutions (such as the International Monetary Fund), conditions attached to the credits generate recessionary adjustments in deficit countries. However, surplus countries are never forced to follow more expansionary macroeconomic stances (UNCTAD, 2015f). Similarly, the lack of international mechanisms to facilitate sovereign debt restructuring tends to delay corrective actions by borrowers and recognize the debt problem when a crisis is already inevitable; at this point, private capital inflows stop, official credit is used to bail out private lenders instead of financing the necessary imports, and debtor countries enter into economic depression and deep financial and fiscal crises. These asymmetric, unfair and procyclical adjustments should be replaced by an approach that seeks to soften recessions in deficit countries, increase aggregate demand in surplus economies and restore debt sustainability through debt restructuring and growth (UNCTAD, 2015a).
Finally, commodity-exporting countries should be better protected against price volatility. In particular, the functioning of commodity markets should be improved by increasing transparency in physical and derivatives markets and putting in place an internationally coordinated tighter regulation of financial investors - for instance, by imposing position limits or a transaction tax. In addition, market surveillance authorities could be mandated to intervene directly in exchange trading on an occasional basis by buying or selling derivatives contracts with a view to averting price collapses or deflating price bubbles (UNCTAD, 2011a). In a longer-term perspective, the best strategy for commodity-exporting developing countries to reduce their vulnerability to external shocks is economic diversification.
How may the global macroeconomy be measured and assessed? Generally speaking, the type of indicators typically used to assess national macroeconomic stability are: price inflation; growth in real GDP; changes in employment/unemployment; current account volatility; health of government finances; interest rate volatility (and government bond yields); and exchange rate stability. The European Union defined macroeconomic stability in law (the Maastricht Treaty17.45 as comprising of four criteria and five indicators: low and stable inflation; low long-term interest rates; low national debt relative to GDP; low deficits; and currency stability. Following the financial crisis, the European Union adopted a broader Macroeconomic Imbalance Procedure scoreboard to help identify macroeconomic imbalances. This scoreboard comprises of 14 headline indicators (with thresholds) and 25 supplementary indicators (without thresholds). Beyond the indicators specified by the treaty, the scoreboard includes indicators relating to export market share, private sector debt, house prices, unemployment (including youth and long term), participation rates and labour costs. The supplementary indicators include labour productivity, residential construction, poverty, deprivation and social exclusion, spending on research and development, foreign direct investment flows and stocks, gross fixed capital formation and GDP. The European approach illustrates the interconnectedness of the real and financial economies with society and the number of factors that may influence macroeconomic stability.
Given the complexity of global macroeconomic stability, the Inter-agency Expert Group on Sustainable Development Goal Indicators (IAEG-SDG) has selected, like the European Union, a macroeconomic dashboard rather than a single measure as the appropriate indicator. Although the actual components of that dashboard are not specified, one might imagine that it will include measures or indices of global liquidity, income inequality, public investment, sovereign and corporate debt and global commodity prices. New types of indices measuring the extent to which the global economy has been financialized or the existence of capital controls for prudential macroeconomic policy may also need to be developed.