New policies needed to prevent a 'third wave' of crisis from threatening world economy
As markets enter a new phase of uncertainty, creative policymaking is needed to stop a third crisis from causing global economic catastrophe
World policymakers face a major new challenge as signs show the global financial crisis entering a new phase of uncertainty. This time there are far fewer policy options left to stop any new downturn turning into a rout. The pressure is on to find new solutions fast.
The threat of a rate increase by the US Federal Reserve, fears of a steeper slowdown in China and recent stock market wobbles have put warning shots across the global outlook.
Ripple effects are spreading around the world. From major industrial nations to emerging markets, economic confidence is taking a hard knock and deflation risks still abound. It is time for policymakers to build better protective fences.
But owing to the policy responses in tackling the Anglo-Saxon crisis in 2008-9 and the euro zone troubles of 2010-12, standard and unconventional rescue remedies are now in short supply.
Interest rates and government debt yields are at rock-bottom levels, monetary stimulus from earlier quantitative easing (QE) efforts is fast losing traction and high levels of global indebtedness leave little left over for fiscal reflation. It is easy to understand why anxiety levels are rising in world financial markets.
A US rate rise seems on the cards fairly soon. US inflation may be within a whisker of negative territory, but robust 3.9 per cent US GDP growth in the second quarter looks enough to swing the Fed's case for an early move.
International factors still suggest otherwise. China may be sticking to plans for 7 per cent GDP growth this year, but the data is far from encouraging right now. China's flash factory PMI sank unexpectedly to a 61/2-year low in September, revealing rising excess slack in the economy.
Meanwhile unfolding troubles in Germany's car industry suggest the economy could lose a large chunk of future growth potential if global demand for German cars starts to slide.
With global leading indicators losing momentum, it is no surprise investors are on tenterhooks. The world needs lower rates, extra QE, more fiscal stimulus and new policy initiatives.
Despite the Fed's wish for higher rates, thankfully the global monetary policy bias is still tipped overwhelmingly towards easing. And more flows of QE money will be coming on-stream from the euro zone for at least the next year.
The major worry for policymakers is ensuring the extra QE cash generated ends up where it is most needed - in consumer and corporate borrowers' hands - and is not warehoused to shore up banks' badly battered balance sheets.
In the euro zone, the European Central Bank must give commercial banks incentives to increase new lending significantly. Quantitative lending targets need to be enforced to ensure the new money being created ends up revitalising economic activity and growth.
Meanwhile, the International Monetary Fund is calling on countries to ditch austerity in favour of fiscal reflation to boost growth. In Europe, this is at odds with the EU's Fiscal Stability Pact, which aims to cut budget deficits and reduce government debt, but it is a vital precondition to jump-start Europe's recovery.
Even heavily debt-laden Japan will need to consider a new fiscal reflation drive. The economy has slipped back into deflation for the first time since the Bank of Japan's monetary stimulus programme began over two years ago and there are growing doubts about whether heavy money printing alone can accelerate inflation to hit the Bank of Japan's 2 per cent target.
Central banks must consider new ways to fend off impending crisis. A move to higher rates in Britain is not a foregone conclusion. Even Bank of England chief economist Andy Haldane has suggested Britain might need to cut rates again.
Hints of more radical action, including the notion of abolishing cash and the introduction of state-issued digital currencies, reveal a possible paradigm shift by British central bankers in thinking outside the box.
Zero interest rates and QE marked a revolutionary step in solving the first two waves of the global financial crisis.
A new leap forward in creative policymaking is now needed to stop a three-part crisis turning into a greater global catastrophe.
David Brown is chief executive of New View Economics