Residue of the Great Recession

December 23, 2009

Drummond- Don Drummond is Chief Economist at TD Bank Financial Group. The opinions expressed are his own. -

The Great Recession is over in North America.  But repair will be a slow work in progress and great risks remain.  Many of these risks are centred on policy matters.  The recession shook our understanding of some policy matters to the core, leaving more questions than answers.

The Great Recession produced deep output and employment losses in many countries, certainly including Britain and the U.S., but also an unprecedented degree of synchronization around the globe. 

That synchronization produced the first annual output loss for the global economy since data began in the early 1960s.  Fortunately, we are also seeing synchronization in the recoveries, to the point that global output should rise about 4 per cent in 2010. 

The tighter degree of synchronization of cycles is likely a permanent feature of the global economy going forward.  In part, it reflects unprecedented co-ordination of policy responses.  International policy co-ordination could help promote growth and reduce the severity of cycles if the group-think reflects wisdom.  But errors could have magnified impacts of taking almost all economies down.  Much is at stake.  But much is also in question.

The Great Recession shattered an emerging smugness in monetary policy circles that keeping inflation low and stable would at least dampen cycles if not eliminate them.  At best one can only say now that controlling inflation is a necessary but not sufficient condition for economic stability. 

Monetary authorities, above all in the UK and the U.S., produced shock and awe with the breadth, depth and rapidity of their actions in driving down interest rates and injecting liquidity and capital. 

Their actions have been key to containing the recession and getting economies growing again, but they still have a daunting task before them in removing the extraordinary stimulus.  Too fast and they will kill the nascent recovery.  Too slow and they will risk inflation.  Surgical precision will be required to navigate between the two risks.

The Great Recession taught that great harm that can be done by regulatory neglect.  Lax regulations on mortgages and insufficient capital of financial institutions proved a toxic mix that undid the economies of Europe and the United States but also shot down many others, such as Canada, in the collateral damage. 

Efforts are underway on a collective basis, such as through the G20, and in individual countries, including the UK and the U.S., to address the regulatory oversights.

Great uncertainty shrouds the processes.  Will the global bodies be able to hit the Goldilocks spot?  Tight enough regulatory control to prevent another catastrophe, but not so tight that credit is choked off, impairing the recovery.  And will individual countries cede to the broader regulatory movement?

Most countries bucked the conventional wisdom on fiscal policy and introduced massive stimulus.  There had been a fairly tight consensus prior to the Great Recession that fiscal policy was not very effective in combating cycles. 

It typically impacted economies too late but left a gigantic debt head-ache that went on long after economies were recovering.  But it was argued that these were extraordinary times, calling for extraordinary measures.  So the clarion call was for all countries to implement fiscal stimulus packages amounting to at least 2 per cent of GDP. 

The stimulus has had a limited impact in lifting economies out of recession.  Particularly in the case of infrastructure spending the economic impacts are still largely to be felt.  But the deficit and debt impacts are sure registering.  Everyday news hits of another country being forced to face the necessity of doing a fiscal about face. 

Few face more pressing fiscal problems than the U.K. and the U.S., where, respectively, debt-to-GDP ratios have soared to over and almost 100 percent.  These will not be easy to address, especially with the explosion in health-care spending.  The verdict on the fiscal policy reply to the Great Recession cannot be rendered for a few years, to see if countries are still drowning in the sea of debt caused both by the economic cycle and their own actions.

The Great Debate on the Great Recession cannot be necessity be put to bed any time soon.  This is the recession that will unfortunately go on giving, both in terms of a sluggish recovery and continuing policy challenges.  How the policy authorities respond to the aftermath of the recession will need to be seen before proper judgement can be applied to their actions during the crisis.

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