How economic policies in EU and US are diverging post crisis

Peterson Institute for International Economics and Bruegel Thinktank organised a conference titled – The Transatlantic Relationship in an Era of Growing Economic Multipolarity.

In it there was an interesting paper presented by Jean Pisani-Ferry and Adam S. Posen. They say the policies in EU and US converged as the crisis started and have diverged as crisis situation eased. They look at a number of reasons for  the above behaviour and summarise the findings:

First, economic developments in the US are in some respects more worrying than those in Europe, and warrant more aggressive policy action. While GDP has rebounded faster, the sustainability of that recovery is now in question, while  employment has declined significantly more, both in absolute terms and in comparison to previous experiences. Furthermore, the extent of deleveraging that remains to be completed in the non-financial sector is without doubt more important in the US, which implies that the drag on domestic demand will remain for longer.

Second, political economy factors add t o this objective assessment. For reasons that have to do both to its history and to its limited institutions for social protection, the US polity clearly has a lower tolerance to unemployment than European polities,  including that of the UK. So the pressure to stimulate is bound to be more significant.

Third, an important source of divergence could be laid to fundamentally different beliefs about the nature of the recovery from the common shock. The US government believes that the American growth trend and potential output have not been lastingly damaged by the shock, consistent with their postwar recessionary experience; the EU governments (including the UK) believe that their economies’ growth trends and aggregate supply have been severely damaged by the shock, consistent with their own past recessionary experiences. As a result, the US government and Federal Reserve officials are far more inclined to maintain aggressively expansionary macroeconomic policies than their counterparts in Brussels, the ECB and most European capitals.

Fourth, institutional factors play a major role as well. The absence of a central fiscal authority, the dispersion of national situations and the lack of global currency status make the euro area economies much more vulnerable to market attack for their fiscal situation than the US. This has contributed to triggering a race to consolidation that would not have happened, had the euro area relied for stabilisation on a federal budget in the same way the US does.

It should finally be added that the financial system rescue and restructuring policies also began to diverge as distance from the initial shock was felt. The false perception among policymakers in the Euro Area seemed to be that since the Anglo-Saxon type of finance was the source of crisis (a valid claim to a substantial degree), European banks were not going to suffer as much or require as much restructuring as banks in the UK or US (a false hope). Again, institutional structures limiting coordination within the euro area regarding application of banking standards or on fiscal expenditures, as well as a greater pre-crisis extent of semi- and fully public banks, reinforced this tendency to be less aggressive than the US or UK in cleaning up banks on the continent.

Fascinating stuff.  One gets to know and compare policies in US and Europe. Broadly policies have differed as two countries are different and faced different shocks.

Why are these divergences important? They point to couple of reasons:

  • International spillovers – both are facing trying economic times and diverse policies could just complicate global sentiment
  • Risk of protectionism – nothing to explain here…
  • Impact on global adjustment- will slow
  • self fulfilling prophecy

Read the paper for more details.

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