Development challenges and policies to overcome the crisis
Monetary policy and interest rates
Before the global economic crisis, monetary policy had been fixated on inflation control, giving only secondary importance to other goals such as full employment. Central banks were seen as the defenders of price stability, and the consensus was that they should remain independent from the pressures of governments. Monetization of debt was seen as a quintessentially inflationary phenomenon that should be avoided at all cost. In addition, the rate of interest controlled by the central bank was the fundamental tool to keep prices under control. In that sense, relatively high interest rates to discourage excessive expansion of demand was key for inflation-targeting strategies that dominated the theoretical debate and the policy practices around the world before the crisis.
Fiscal policy
This section discusses the relation between fiscal balances and economic activity. Too often fiscal austerity has been described as a necessary tool for economic growth, in the so-called expansionary fiscal contraction literature. However, the evidence suggests that excessive public spending and debt accumulation did not cause the current situation, and that the further adjustment of government spending, particularly in developed countries, could make things worse. This contrasts with developing countries where the fiscal stance was more stimulative after the crisis, based on expanding spending rather than on tax cuts. Policies to promote growth and employment like investment in infrastructure and in green technologies might be more relevant to promote lower debt-to-GDPGross domestic product ratios than fiscal austerity.
Incomes policy
Incomes policy is the suitable complement for expansionary monetary and fiscal policies, in particular under conditions that reduce the space for further macroeconomic expansion. Over the last 30 years, economic growth in developed countries has relied less on consumption booms on the basis of expanding wages than on increasing private indebtedness, or more on export markets, which often rely on compressed wages. This proved to be unsustainable. In some developing countries, wage expansion has proven to be a more reliable source of demand expansion. A policy that maintains real wages expanding in line with productivity would provide a sustainable source of domestic demand expansion.
Re-regulation of the financial system
Deregulated financial markets are prone to crisis: Credit supply is by nature pro-cyclical, herd behaviour is dominant and regularly leads to self-fulfilling prophecies. These conditions have been aggravated in the last decades by wider liberalization and financial innovation, which affected transparency and incentives, weakened supervision and expanded leveraging. Following the financial crisis, re-regulation has been dominated by the view that increased reserve requirements, and smaller financial institutions would be sufficient for curbing future crises. Further, the view that financial markets should regulate themselves is still quite predominant. The process of re-regulation has been incomplete, and further measures are needed to reduce the likelihood of financial crises.
Special challenges facing emerging market economies and least developed countries owing to the volatility in commodity prices
The financialization of commodity markets has come hand in hand with increasing volatility of commodity prices, which are a fundamental component of the exports of several developing countries. Commodity prices rebounded from the crisis incredibly fast, but since the second quarter of 2011 have undergone a negative trend. Volatility in commodity markets is dangerous for developing countries, since it affects growth negatively in exporting countries when they fall precipitously, and it might lead to food and energy shortages in developing import countries when they grow too fast. Regulation of financial markets to reduce volatility of commodity prices would reduce the chance of growth collapses and hunger in the developing world.
Policy recommendations
The two-speed recovery, fast in the developing world and slow in advanced economies, continues. Developed countries moved back to contractionary fiscal policies for fears of excessive accumulation of public debt. Those fears are misplaced, and further fiscal and monetary expansion is actually required to avoid further economic slowdown. Financial re-regulation is essential for the stability of the global economy but it remains unfinished. Incomes policy that promotes the adjustment of real wages in line with productivity should also be considered, particularly in developed countries where wages have grown at lower rates. Monetary policy should move beyond inflation targeting and be also concerned with the level of activity.