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Financial Crisis Crunch November 20, 2008, 5:00PM EST

Fighting the Global Slump: Less Is Dangerous

(page 2 of 2)

German stocks fall; critics say Berlin isn't doing enough to halt a slump Hermann Bredehorst/Polaris

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Hardest hit are small, open economies such as Ireland, Iceland, and Taiwan (all island nations) that were exemplars of globalization and financial innovation just a few years ago. They relied even more than the U.S. on free flows of trade and investment. But big European countries such as Britain, France, and Italy also feel their ability to stimulate is limited. "The British government has been wildly promiscuous with public debt over the last 10 years," says Geoffrey Wood, an economist at Cass Business School of City University London. He says British public debt "will inevitably take its toll on the pound. There's no logical floor for how long it could go against the dollar."

Least affected are several big countries, such as China, that are beginning to switch from export-driven growth to domestic demand. The IMF expects China's economy to expand 8.5% in 2009—not bad, albeit the country's first year of single-digit growth since 2002. Beijing announced plans for $586 billion in stimulus over two years to keep things humming. Indonesia, surprisingly, chugged ahead at a 6.4% rate in the third quarter, driven by domestic demand. And sub-Saharan Africa is also likely to be spared, if only because much of it is desperately poor and barely tied to the global economy.

The world economy's ordinary shock absorbers are inadequate for a crisis of this scale. Central bank reductions in interest rates are becoming less effective because people are afraid to borrow no matter how low the rate. And of course, rates can't be cut below zero.

As a result, governments are being forced to turn to spending programs that are not part of their usual recession-fighting arsenal. In addition to the usual tax breaks and rebate checks, they are resorting to government loans and investments in financial institutions, as well as debt guarantees aimed at restarting private lending. Many countries are pursuing all three.

The bad news is that government responses do not yet match the scale of the crisis. The good news, on the other hand, is that governments have more elbow room than usual to borrow and spend because, with the plunge in commodity prices and slack in labor markets, inflation is no longer an immediate threat. On Nov. 19 the U.S. Bureau of Labor Statistics reported a 1% drop in consumer prices in October—the biggest monthly decline since the bureau began tracking those figures in 1947.

Recognizing the risks of a debt-deflation spiral, aides to President-elect Barack Obama are working on plans to ask Congress to spend up to $500 billion more. Other countries may have to follow suit. In the end, a synchronized recession will require synchronized stimuli.

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IMF: Go Ahead and Spend

John Lipsky, first deputy managing director of the International Monetary Fund, said in a Nov. 17 speech that the IMF's research shows that more aggressive fiscal stimulus around the world is justified. "Countries with the strongest fiscal policy frameworks, those best able to finance new fiscal efforts, and those with clearly sustainable debt positions should take the lead," Lipsky said.

To read Lipsky's speech and see a video, go to http://bx.businessweek.com/global-recession/reference/

Coy is BusinessWeek's Economics editor.
With Jason Bush in Moscow, Mark Scott in London, and Carol Matlack in Paris

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