The world faces a “lost decade” of economic growth unless policymakers on both sides of the Atlantic take action to boost growth rather than pursue austerity, Larry Summers, a former top economic adviser to US president Barack Obama, warned in an interview with Emerging Markets.
Summers, former chairman of the White House’s National Economic Council, said that continued austerity in the eurozone and a failure to address the looming US fiscal cliff would prove disastrous for the world economy.
“The appropriate emphasis today in almost every part of the world has to be on the promotion of growth,” he told Emerging Markets in a telephone interview on his way to the IMF annual meetings in Tokyo. “The risk we face is of a lost decade of potential economic growth in large parts of the world.”
He said the experience of Japan, whose GDP is between a third and a half below the level that most people would have expected in the 1990s, was “cautionary” about the consequences of allowing “cyclical problems to harden into structural problems”.
Policymakers needed to understand that the dominant reason for economic weakness was lack of demand, which in turn was the result of the deleveraging associated with the “major loss of confidence” that has taken place.
“It’s the central irony of financial crises that while it’s caused by too much overconfidence, too much borrowing and lending and too much spending, it is only resolved through more confidence, more borrowing and lending and more spending,” he said.
A global recovery would depend on “the extent to which the problem is recognized as a deleveraging demand problem and addressed in those terms.” But he added: “We are well short of the necessary recognition.
“We are no longer in a great recession, we are on the brink of a great stagnation if we are not able to enhance confidence and grow the economy more rapidly. “
Summers said the US economy running off its fiscal cliff would have devastating consequences. “The last thing that the world economy needs right now is a major contractionary impulse coming from the United States. We have to desperately hope that we don’t get one.”
But he said US lawmakers were likely to at least forge a partial compromise in order to avoid the fiscal cliff. “When all that is required is that a can be kicked...even a lame duck session of Congress will be able to do that,” he said, although he added that “there are certainly no guarantees.”
Regardless of whether Obama or Massachusetts governor Mitt Romney wins next month’s elections, the next US administration must prioritize “the restoration of growth and the re-attainment of the economy’s potential”.
Failure to fix public finances and boost growth could result in a bond market revolt, Summers warned. “Ultimately US finances are not on a sustainable basis. We need to find a combination of growth promotion then fiscal adjustment that remedies those imbalances,” he said.
“If we don’t do that those who warn that there will eventually be consequences in bond markets are absolutely correct.”
It had become increasingly clear that there was overwhelming political will in Europe - including in Germany - to maintain the single currency and to avoid what would really be the “quite extraordinary risks associated with even the partial dissolution of the monetary union”.
In order to minimise the chances of a euro break-up, it was essential that leaders embarked on a growth strategy that involved both debtor and creditor countries and which showed the continent was capable of political unity.