G7 leaders must recognise that monetary policy alone won’t solve the world’s ills
Hosting a successful family get-together is a stressful business. Just ask Japan’s Prime Minister Shinzo Abe. With the leaders of the world’s major economies arriving in Ise-Shima for a G7 summit, Abe has promised “candid” and “fruitful” discussions to tackle the challenges to global growth. But against the backdrop of sluggish activity, doubts about the effectiveness of monetary policy and accusations of aggressive currency devaluations, this may be easier said than done.
So what can we hope for from the G7, and what can we realistically expect? We would like to see progress in three main areas: monetary, fiscal and structural policies.
Global growth and inflation remain anaemic, despite seven years of exceptional monetary stimulus. Against this backdrop, the G7 needs to shore up the credibility of central banks, while acknowledging the negative side-effects of monetary action.
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What we do not want is any sign of a breakdown of the wider G20’s commitment to avoid destabilising currency wars. With a number of countries, including Japan, recently added to a US government “watch list” of potential currency manipulators, this is clearly a sensitive issue. At the same time, some comments reflecting on the limits of negative interest rates would be helpful, to address concerns about their impact on the financial sector. Such words should be accompanied by a statement of confidence in central banks’ independence and their full possession of a range of tools to “do the job” for the global economy.
But monetary policy alone cannot solve the world’s ills. The host nation has recognised this: despite having a government debt burden of around 230 per cent of national income, Japan has combined activist monetary policy with an unprecedented fiscal stimulus over the past few years – with mixed results. Abe should lead by example at Ise-Shima, with a fresh fiscal package of around ¥10 trillion (£61bn). A postponement of next year’s consumption tax rise may be less likely, following better-than-expected recent growth numbers. Given the fragility of Japan’s economy, however, Abe would be unwise to rule out such a delay altogether.
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It would make a lot of sense for the G7 to boost infrastructure spending. But what are the chances, even in a world of exceptionally low funding costs? Canada’s Justin Trudeau is certainly enthusiastic – declaring that he is “very much on the investment side of the investment-versus-austerity debate” – but others are less so. The UK and Germany may be able, but they are not willing; and while Italy and France may be keen, their Eurozone commitments provide little room for manoeuvre. As for the US, the looming presidential election leaves Barack Obama with little that he can meaningfully do. So a coordinated G7 fiscal boost is unlikely.
Which brings us to structural policies. These come in two varieties: reforms to increase competition among firms by deregulating and encouraging business startups, and reforms to boost worker productivity by increasing labour-market flexibility and raising participation. Abe should lead the way, with measures including specific targets for female labour-market participation in Japan. Increasing spending on active labour market policies, encouraging matching between firms and job seekers, would also make sense. Combining structural reform with complementary fiscal support could strengthen activity in the near term by raising consumer and business confidence, as well as boosting the long-term growth potential of economies.
But structural reform is the area where countries have made least progress in recent years. So although a clear plan of action would be highly desirable, it may not be forthcoming.
Of course no family gathering would be complete without an important guest who probably should be there, but isn’t. In this case it is China. Though not a member of the G7, it is now the world’s second-largest economy. And as recent periods of market turmoil have shown, China’s actions have a hugely important bearing on the outlook for the world economy.
Abe is hoping that, with the “cooperation and assistance” of his guests, he will be able to “lead the G7 summit to success”. Will he? It all depends on your definition of success. He won’t solve all the challenges facing the world economy. He seems unlikely to achieve all that we would like to see by way of monetary, fiscal and structural progress. But at the very least, as all families know, it’s good to talk.