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Global Viewpoint

Rebalancing the world economy after recession

If the US revives consumption and China revives exports, nothing will change.

By Raghuram G. Rajan / August 9, 2010



Chicago

There is a fair amount of consensus that the world economy is in need of rebalancing. Countries like Iceland, Greece, Spain, and the United States overspent prior to the crisis, financing the spending with government or private borrowing, while countries like Germany, Japan, and China supplied those countries goods even while financing their spending habits.

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Simply put, the consensus now requires US households to save more and Chinese households to spend more in order to achieve the necessary rebalancing. Indeed, many believe that if only the United States toned down its consumerist culture and its households tried to stay within a monthly budget instead of having a Micawberish optimism about the future, and if only Chinese households stopped fearing Armageddon and started spending more, all would be well.

Of course, it is simplistic to reduce global trade imbalances to a bilateral imbalance between two countries. But since this is how the popular debate is posed, it is useful to ask whether rectifying the imbalances is only a matter of US and Chinese households switching personalities.

Clearly, consumer behavior is driven by habits formed over time, many of which are culturally determined – driving a Hummer, the gigantic low-mileage SUV, used to be an acceptable means of signaling the size of your wallet in the United States before concerns about global warming spread. No longer! However, the focus on consumer behavior misses the deeper policy underpinnings of the behavior we see.

How Uncle Sam promoted consumer debt

In the United States, for example, credit-fueled consumption may have been exacerbated by the government’s push to expand home ownership, especially among low-income households. As house prices rose, households felt wealthier and borrowed against the home equity they had built to finance their lifestyle. Indeed, this bought successive administrations political peace as debt-fueled consumption helped paper over the fact that incomes for the median household barely increased.

A second factor pushing US households to take on debt and consume has been the Federal Reserve’s policies. With US recoveries proving slow in creating jobs, and with consumption accounting for about 70 percent of demand, the political pressure on the Fed to revive the economy forces it to try to discourage household savings in downturns by keeping policy rates at ultra-low levels for sustained periods of time.

But if households do not save in downturns, how likely are they to save as the economy recovers and euphoria kicks in?

Finally, as other countries come to see that the United States is willing to be the world’s consumer of first and last resort, they are happy to rely on it to provide the extra demand to lift the world out of recessions, even while Americans get their finances in order. So policies around the world make the United States household the world’s designated spender.

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