23 September 2011

Duvvuri Subbarao: US recession anxiety and the eurozone sovereign debt crisis

Dr Duvvuri Subbarao, Governor of the Reserve Bank of India, spoke at the International Monetary Fund Meeting in Washington DC, saying that renewed anxiety in the US about recession and the deepening of the sovereign debt crisis in the euro area were both cause for concern.

"Each is by itself a big risk, but the bigger risk is that both could materialise simultaneously, and interact with each other with adverse feedback loops manifested through trade, finance and confidence channels.

Political gridlock

"The problems are well known, and the solutions are on the table. The main impediment to an effective resolution common to both flashpoints appears to be political.

• In the US, the central issue is managing the tension between fiscal stimulus in the immediate term, and credible fiscal consolidation over the medium- to long-term.
• In the euro area, there is a shared monetary framework, but without a shared fiscal framework. What is standing in the way of a credible and confidence inspiring resolution of the fiscal-financial imbroglio are political compulsions.

2008 and 2011

"To understand the situation today, let us throw back to the global crisis of 2008. Then too, we faced similar extreme siege conditions of the global financial system, and the challenge of responding immediately and decisively to the crisis within the boundaries of democratic processes. We managed that challenge. The G20’s leadership and the all-out efforts mounted by the IMF and other multilateral institutions to do what it takes to pull back the global economy from the brink of collapse and set it on a path of recovery were applauded across the world.

"There are important differences between the 2008 crisis and today’s situation:

i) In 2008, when the world got into a crisis, there was a lot of policy force. In the years before the crisis, the world enjoyed the so called “Great Moderation”, with steady growth in advanced economies and accelerated growth in the emerging economies, and low inflation all around. So we could attack the crisis with the full fire power of monetary and fiscal stimulus. Sadly, the policy space for stimulus is much less today.

ii) In 2008, the world responded to the crisis in coordination. Sure there were differences, but these differences were resolved, and governments and central banks acted firmly, decisively and, where required, creatively. A similar perception of coordination is lacking today.

iii) In 2008, both advanced economies and EMDCs were at the same phase of the business cycle. Today, they are at different phases of the business cycle.

iv) In 2008, the crisis originated in the financial sector and transmitted to the real sector, but the rescue was by the public sector. In 2011, it is the other way round. The crisis is originating in the public sector and hitting the financial sector, and undermining the confidence of the private sector.

"To conclude, there is a great deal of anxiety around the world about the outcome of this weekend’s Fund-Bank annual meetings and the G20 meetings. There are strong expectations that we will converge on a plan of action that will reverse the crisis of confidence. We once again have to show the resolve that we did in 2008 to meet those expectations."

Full speech

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