More action needed to stop the slide

More action needed to stop the slide
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First Published: Mon, Nov 10 2008. 10 24 PM IST

Updated: Mon, Nov 10 2008. 10 24 PM IST
The credit crunch is not under control. Despite global efforts to recapitalize the financial system, credit is still in short supply and potential borrowers are afraid to take on new debts. Governments need to take more direct action to break the downward spiral—tax cuts and, in some countries, increased spending.
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Some of the current deleveraging is healthy—the elimination of the credit fat that made the financial sector flabby and houses look like money machines. A mild recession that helps rebalance the global economy would be welcome. But worthy victims such as hedge funds and over-leveraged oligarchs are no longer the only ones in pain. Tighter lending is cutting into economic muscle—trade and capital investment.
Something needs to be done to keep recession from turning into a huge slump. So far, the attack against deleveraging has involved stuffing banks with capital and slashing official interest rates. More action may be necessary on this front to keep banks lending to worthy customers. But the authorities are right to open a second front.
China says it will spend $600 billion (Rs28.3 trillion), and other governments are talking about offering fiscal stimulus programmes—deficit spending—worth 2-5% of gross domestic product (GDP). The Group of 20 nations said on 10 November that it was prepared to act to bolster growth and called for cuts in interest rates and increased spending.
The goal should be twofold. First, to get cash into the economy. If companies and families can’t or won’t borrow, governments can do it for them. The cash can be pushed through to the private sector to keep investment and spending from falling off a cliff.
Second, to reduce fear. The prospect of corporate bankruptcies has eroded trust and confidence. When too many companies and individuals make rational decisions to tighten belts, the result is a collective disaster. Government stimulus provides a counteracting collective wisdom.
The plans will be more effective if they are coordinated, as UK Prime Minster Gordon Brown has suggested, and substantial. Public works projects—the vogue in the 1930s depression—make sense for China, which has both the infrastructure gaps and the available labour to fill them.
In richer countries, it’s hard to turn surplus investment bankers into road builders. There, simple tax cuts, which work fast and minimize the risks of government economic fiddling, are preferable.
Fiscal action is risky. Tax cuts now have to be compensated by growth-sapping measures later, either tax increases or high inflation. And many governments already labour under heavy debt burdens. But right now inaction is even riskier.
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First Published: Mon, Nov 10 2008. 10 24 PM IST