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Message from ADB's President Contributors Acknowledgements Executive Summary and Recommendations Jeffrey D. Sachs, Masahiro Kawai, Jong-Wha Lee, and Wing Thye Woo Paper Summaries (full papers downloadable) International Monetary Advisory Group Global Financial Crisis, its Impact on India and the Policy Response Nirupam Bajpai To What Extent Should Capital Flows be Regulated? Maria Socorro Gochoco-Bautista The Case for a Further Global Coordinated Fiscal Stimulus Willem Buiter Managing a Multiple Reserve Currency World Barry Eichengreen From the Chiang Mai Initiative to an Asian Monetary Fund Masahiro Kawai An Asian Currency Unit for Asian Monetary Integration Masahiro Kawai The International Monetary System at a Crossroad Felipe Larrain B. Towards a New Global Reserve System Joseph Stiglitz A Realistic Vision of Asian Economic Integration Wing Thye Woo An Asian Monetary Unit? Charles Wyplosz Will US fiscal Deficits Undermine the Role of the Dollar as Global Reserve Currency? If So, Should US Fiscal Policy be geared to Preserving the International Role of the Dollar? Yongding Yu International Monetary Working Group International Reserves and Swap Lines: the Recent Experience Joshua Aizenman, Donghyun Park and Yothin Jinjarak The Future of the Global Reserve System Daniel Gros, Cinzia Alcidi, Anton Brender, and Florence Pisani Renminbi Policy and the Global Currency System Yiping Huang Will the Renminbi Emerge as an International Reserve Currency? Jong-Wha Lee Asia's Sovereign Wealth Funds and Reform of the Global Reserve System Donghyun Park and Andrew Rozanov Reforming International Monetary System Kanhaiya Singh Designing a Regional Surveillance Mechanism for East Asia: Lessons from IMF Surveillance Shinji Takagi

3. The Case for a Further Global Coordinated Fiscal Stimulus

Willem Buiter

The paper considers the conditions that must be satisfied for another internationally coordinated fiscal stimulus to make sense and tallies these against the circumstances prevailing in the advanced industrial countries during the late 2009-early 2010 period.

First, there must be idle resources – involuntary unemployment of labour and unwanted excess capacity. Output and employment are effective demand-constrained. These conditions were undoubtedly still satisfied throughout the industrial world.

Second, there should be no more effective way of stimulating demand, say through expansionary monetary policy. With short-term nominal interest rates at or near the zero lower bound and with quantitative easing, credit easing and enhanced credit support of doubtful effectiveness except when disorderly financial market conditions prevail, this conditions is also satisfied

Third, expansionary fiscal policy should not drive up interest rates, either by raising the risk-free real interest rate or by raising the sovereign default risk premium, to such an extent that the fiscal stimulus is emasculated through financial crowding out. This condition is only satisfied for relatively few industrial countries, those with low public debt to GDP ratios, low primary (non-interest) deficits as a share of GDP and significant scope for raising future taxes or cutting future public spending. Political economy considerations such as the degree of polarisation of the polity, the effectiveness of key political and economic institutions and the quality of the incumbent political leadership are the key drivers here. A few countries have extraordinary buffers that protect them from the normal working of market discipline through the ‘bond market vigilantes’ and similar channels. The most important are the US, protected for the time being by the global reserve currency status of the US dollar and Japan, protected by its large stock of net private financial assets and the very high degree of passive domestic ownership of its public debt.

Fourth, at given interest rates, the expansionary fiscal policy measures are not neutralised by direct crowding out (the displacement of private spending by public spending or of public dissaving by private saving at given present and future interest rates, prices and activity levels). Such direct crowding out can occur in the case of tax cuts (strictly speaking, cuts in lump-sum taxes matched by future increases in lump-sum taxes of equal present discounted value) because of Ricardian equivalence/debt neutrality. In economies with very highly indebted households, debt neutrality can occur when taxes on households are cut, because of what the author calls ‘Minsky equivalence'. Increases in public spending on real goods and services (‘exhaustive’ public spending) can fail to boost aggregate demand because of a high degree of substitutability (in the utility functions or the production technology) between private consumption and investment on the one hand and public consumption and investment on the other.

There is little if any empirical support for Ricardian equivalence. Minsky equivalence is untested but, the author argues, plausible in a world with highly indebted and suddenly highly risk-averse households. If it is present, it would be good news for those countries that have to tighten fiscally to meet the demands of skeptical markets that doubt their fiscal sustainability.

Fifth, there must be cross-border externalities from expansionary fiscal policies that cause decentralised, uncoordinated national fiscal expansions to be suboptimal. This is bound to be satisfied in a world of imperfectly competitive producers and employers operating under conditions of inadequate effective demand.

It follows that the conclusions on the scope for further conventional expansionary fiscal policy now is rather discouraging in nations with high and rapidly rising public debt burdens, unless there is scope for political realignments that support coalitions in favour of significant future fiscal tightening through tax increases or public spending cuts. The paper also outlines some unconventional fiscal/financial policies that may be effective in their own right and may help to enhance the effectiveness of conventional expansionary fiscal policy. Collectively, they can be characterised as the equitization of debt – household mortgage debt through the issuance of ‘Islamic mortgages’, bank debt through mandatory conversion of unsecured debt into common equity, and public debt through the issuance of instruments like GDP growth warrants or floating rate debt with the ‘interest rate’ indexed to the growth rate of nominal GDP.