Wrestling With the Risks and Rewards of a Global Economy

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Lately it seems impossible to talk about the U.S. economy’s ailments and challenges without mentioning the rest of the world.

Lately it seems impossible to talk about the U.S. economy’s ailments and challenges without mentioning the rest of the world. Recent research by International Monetary Fund economists (reported in a Reuters story here and detailed in this IMF white paper) shows that advanced and emerging economies have become increasingly interlinked over the past decade, particularly through financial markets, with good and bad implications for individual countries. On one hand, cross-border financial linkages diversify risk, reducing an individual country’s exposure to localized shocks. On the other hand, the IMF warns that such interconnectedness can mean that financial risks can be transmitted quickly when they affect a major economic player (they use the term “core node”), possibly leading to a breakdown of the entire, global system.

 Moreover, it’s clear that the world’s economies are in many cases fighting off our own individual but similar economic ailments. The U.S. is watching Europe with keen interest, not just because we are afraid of the negative spillover from a deeper European recession, but because European countries are sparring and struggling over how to get to greater fiscal sustainability at a time when their economies are so fragile. Sound familiar?

At the conclusion of last week’s G20 summit in Los Cabos, Mexico, leaders issued a statement (the “G20 Leaders Declaration”) that began: “We are united in our resolve to promote growth and jobs.” They talked about their need to “work collectively to strengthen demand and restore confidence. . . to create high quality jobs and opportunities” at the same time they  “remain committed to reduce imbalances by strengthening deficit countries’ public finances with sound and sustainable policies that take into account evolving economic conditions.”  Over and over they are mindful of the tension and sometimes conflict between shorter-term and longer-term goals.

In paragraph 12 of the leaders’ declaration, they talk about the delicate balancing act generally, and then more specifically about the U.S. situation (emphasis added):

“All G20 members will take the necessary actions to strengthen global growth and restore confidence. Advanced economies will ensure that the pace of fiscal consolidation is appropriate to support the recovery, taking country-specific circumstances into account and… address concerns about medium term fiscal sustainability. Those advanced and emerging economies which have fiscal space will let the automatic fiscal stabilizers to operate taking into account national circumstances and current demand conditions…. Recognizing the need to pursue growth-oriented policies that support demand and recovery, the United States will calibrate the pace of its fiscal consolidation by ensuring that its public finances are placed on a sustainable long-run path so that a sharp fiscal contraction in 2013 is avoided.

In other words, no “fiscal cliff!” The rest of the world is as concerned about how the U.S. will deal with our challenges as we are about how Europe will deal with theirs. How each of the G20 countries lead on these dual economic challenges in terms of the choice and timing of fiscal policies will determine how the world’s economies rise or fall. We are all in this together.

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