In a way few predicted only weeks ago, reality is knocking at the G20’s door: the European debt crisis has taken a turn that threatens the global economy. The plans for the next meeting of heads of state or government, convened for November 3 and 4 at Cannes, need rethinking.
Still today, the G20’s agenda focuses on the “old” priorities, dictated by the 2008 US-centred banking crisis and the resulting recession. It continues to rest on two pillars, financial regulation and macroeconomic governance (aggregate demand rebalancing in particular), plus institutional reform in various areas (primarily the IMF, and more recently, under French guidance, the international monetary system). These lines of action have progressed usefully and should not be forgotten, but are increasingly inadequate to tackle today’s paramount problem, the risk of financial contagion from the sovereign sectors. The epicentre of this risk is in Europe.
Events have accelerated sharply. Until June this year, one could still hope that the euro-debt crisis could remain confined to a handful of small countries, financially distressed but on the whole manageable. After all, Greece, Portugal and Ireland combined represent a mere 6 percent of euro area GDP. The European rescue fund and the existing political resolve seemed sufficient to provide a backstop. Even some policymakers’ hesitations – for example, in deciding the mix between fiscal adjustment and private sector involvement – did not seem excessively threatening, given the small amounts involved.
With two large countries (Italy and Spain) under fire, the risks have taken a globally relevant proportion. There are at least three transmission channels. First, distressed sovereigns will implement harsh fiscal adjustment packages – this is already happening – with direct consequences on aggregate demand. Uncertainty and precautionary spending behaviour will likely extend to more stable countries. In Germany, in spite of the recent export-driven expansion people are increasingly concerned by financial and political developments they do not understand and perceive as deeply damaging for their country. Second, financial institutions will come under renewed stress, not only in Europe. The extent of this is difficult to foresee given the potential for second-round effects. Third, as the process unfolds, new bouts of exchange rate and financial market instability are possible.
On August 8, the G20 expressed its “commitment to take all necessary initiatives in a coordinated way to support financial stability” and its readiness to “take action to ensure financial stability and liquidity in financial markets”. An impressive battle warning, but transforming words into effective communication will require more. Two avenues could usefully be pursued.
The first is to enhance the macro-coordination framework in the making (see other articles in the G20 Monitor this year) by bringing intra regional imbalances explicitly to the fore, if and when they acquire (or risk acquiring) a global dimension. So far there has been ambiguity in this respect. While Europe insists that its currency zone be treated as a single entity, at least as far as the external position is concerned, the G20 surveillance mechanism is organised on a country-by-country basis. For example, the “systemic” countries singled out as for second round examination in the global imbalances procedure include, reportedly, Germany and France and not the eurozone or the EU; this excludes, for now, all countries whose sovereigns have come under market pressure. A G20 debate in this area would not only be highly relevant to its mandate, but also useful to step up peer pressure leading to policy actions.
Second, there is no reason why the emerging block represented in the G20 should not contribute to provide market support in conditions of stress. This is implied by the August communiqué and would also be consistent with the fact that instabilities that have adverse global spillovers are of common concern in the G20. It is in the interest of all members, particularly the large debtors and exporters, that global bond markets remain stable. Undoubtedly, a support mechanism for European debt markets that included, in addition to the existing EU actors, the large G20 creditors, would convey a strong and possibly decisive signal to market participants. Support should be accompanied by adequate conditionality, consistent with IMF and EU practices.
The G20 was created in 1998, and reshaped in 2008, with a marked crisis management imprint. As the winds of financial instability resume it may need to revert to that mode after some time of tranquil sailing. The more pre-emptive its action is the better. Cannes offers an opportunity.