Economist: Too much belt-tightening risky for global economy

The world’s major economies are in a dangerous race to impose austerity policies that could spill over into another global recession, the new head of one of Washington’s most influential think tanks on the economy warned Wednesday.

Greece’s fiscal problems are pressuring the world’s leading governments into a “least-ugly contest,” where they try to one-up one another with tighter monetary policies, but the effects of such moves could be dire for growth, said Adam Posen, president of the D.C.-based Peterson Institute for International Economics.

“I think an important aspect of the international scene since early 2010 has been a least-ugly contest among the major economies of everybody saying, ’I don’t want to be Greece. Somehow, I convinced myself I could look like Greece, so therefore, I am going to outbid comparable countries on austerity, in order to do this,’” Mr. Posen, who recently returned to the think tank after serving for three years as a member of the Bank of England’s Monetary Policy Committee, told reporters.

Jacob Kirkegaard, senior fellow at the Peterson Institute, believes that outside of the 17-nation bloc of countries that use the euro as currency, few national government have fully embraced the austerity measures.

In the U.S., if Congress had not solved the “fiscal cliff,” it would have been a dose of “shock therapy” to the economy, he said, but that was avoided — for now — with the deal last week between Congress and the White House.

“The fact is everybody in the euro area has pretty much consolidated at the same time, and you know — surprise, surprise — the euro area in 2012 was in recession,” Mr. Kirkegaard said. “If there had been no deal on the fiscal cliff, and the full effect of the [spending cuts] and expiration of tax breaks had actually come to pass, then the U.S. would have been in recession in 2013. There’s no doubt about it.”

Some of the troubled economies in the euro zone — notably Portugal, Greece, Italy and Spain — have had little choice but to enact austerity measures, given the finances of the bloc and pressure from creditor nations such as Germany.

“For other countries, such as the U.S. and Germany, [austerity] is not good,” Mr. Posen argued. “This is forcing them into premature tightenings and excessively speedy tightenings. The most important thing is that the international spillovers when everybody tightens up at the same time are quite large.”

Instead, Mr. Posen called for a coordinated global effort to ease back from the austerity measures.

“The question is: ’Can we in a somewhat coordinated way bid it down a bit, or spread it over more years, and thereby remove the incentive of the least-ugly contest to make each other look bad, and get to a more beneficial outcome for everyone?’” he said.

But, Mr. Kirkegaard added, “I think the prospect for global coordination is very slim.”

Mr. Posen suggested a “barbell” model for government borrowing, where countries make a big initial payment, then small payments for a while, then a big final payment.

“Even I believe countries have to pay their debts at some points,” Mr. Posen said. “The question is the time sequencing and how you make credible commitments not to overdo it now, but not to underdo it later.”