The financial crisis of 2008 and the ensuing economic challenges for many of the major economies have provided a lot of lessons for economists and those interested in political economy. Whilst we may all be aware of the difficulties posed by a recession, what has not been clear is the success of the various policy measures to lift a country out of the doldrums.
Depending on the country's position, both monetary and fiscal measures have been used in combination. In many of the major economies, monetary policy has been expansionary: interest rates are at record lows (virtually zero) and quantitative easing (printing money) has been employed and inflation mitigation abandoned. Implementation of a regulatory standard, Basle III, which will again increase capital ratios and liquidity guidelines, has been delayed (to 2019) as bank balance sheets have been weakened by the recession. Strengthening bank capital ratios at this time would have resulted in freezing bank lending, at a time when many businesses needed finance.
In the eurozone, where the European Central Bank (ECB) does not have the money-creation powers that most national central banks have, the ECB has had to create other mechanisms and stretch existing ones in an effort to save the euro and the banking sector. And of course Mario Draghi, the head of the ECB, has had to talk markets up by promising to do "whatever it takes". In the US, the Federal Reserve, whose mandate is the control of the money supply, has taken the unprecedented decision to buy bonds to a minimum value of US$65 billion a month, linking it to an unemployment-rate target of 6.5 per cent.
Those countries that have had the fiscal space have run deficits. In Europe, those that have not have had to resort to a combination of the IMF, the European Stability Mechanism and the ECB, (Italy, Spain Greece, Portugal and Ireland) in addition to renegotiating sovereign debt where possible (Greece, Ireland). But deficits cannot continue indefinitely and what we have begun to see is the implementation of austerity measures, either by way of increased taxes, a reduction in benefits and structural reforms where necessary. This not only includes the countries that we would expect (Portugal, Spain, Ireland, Greece, Italy) but other economies that one would have considered to be stronger (Germany, France, England and the US).
But deficits are not bad in themselves. The more difficult issue is how to deal with structural deficits which are defined as deficits that result from a fundamental imbalance between government receipts and expenditures (the Caribbean problem), as opposed to one based on one-off or short-term factors. Structural deficits will eventually pose a problem for any government.
Deficits are financed by borrowing, and continued borrowing leads to an accumulation of debt. The ability to pay off this debt is measured by a country's debt relative to its GDP, referred to as its debt-to-GDP ratio. Therefore a rising debt-to-GDP ratio has negative implications.
The point at which a structural deficit and rising debt-to-GDP ratio can lead to a crisis of confidence depends on the credibility of a country. A country with a long history of not defaulting on its debt will endure large deficits without a financial crisis. The US, for instance, has large structural deficits but is still able to borrow at very low interest rates as it provides the world with the reserve currency. The problem is not the size of the national debt, but the measures adopted to deal with it. Japan has the world's largest debt-to-GDP ratio at 238 per cent, but this is not owed to foreigners but to Japanese nationals.
Deficits, large or small, in themselves will not lead to a decline in economic growth. Rather it is the austerity measures to correct the deficit that lead to economic decline. And this is where the north western world has reached the brink.
Austerity measures have been undertaken in much of the eurozone and have led to a recession this year (2013). England's austerity measures have led to a "triple dip recession" as growth simply has not taken place. In the US, the mini deal done on January 1 has simply postponed the next crisis to March 1 and 27, when the current budget expires, the debt ceiling limit is breached (and parliamentary approval to borrow runs out) and the automatic expenditures cuts are triggered.
To deal with one problem is challenging enough; to deal with all three together in the face of a rudderless, rebellious Republican party creates the prospect of a perfect storm. A recession is on the cards.
Administrations everywhere are muddling through. But at least some of the problems are being addressed. At home, the administration is attempting to wait it out, "whilst these threats are real", but expecting that policy measures will be taken in the metropolitan economies that "will accordingly reduce the prevailing downside risks to the world economy in 2013". This is not happening. And the public discussion/sensitisation on the key policy measures to address the structural deficit is overdue. We cannot simply wait. A credible medium term approach is outstanding.
• Mariano Browne is a former