By Fernando J. Cardim de Carvalho
RIO DE JANEIRO, Dec 30 2015 (IPS)

As 2015 approaches its end, Brazilians live a period of extraordinary uncertainty. The recession seems to get worse by the day. Inflation is high and shows unexpected resistance to tight monetary policies applied by the Central Bank. The sluggish international economy has largely neutralized incentive and the strong devaluation of the domestic currency could represent a reality to exporters and to producers who compete with now more expensive imports. After an initial resistance, employment levels began to fall.

Fernando J. Cardim de Carvalho

Any subset of that list of events would be enough to generate widespread instability. All of them put together created a hitherto unheard of situation of political and economic crisis of which one has to make extraordinary efforts to see any way out.

Impeachment procedures against the president did not come out of the blue. The revelation of the Petrobras scandal has brewed rumors and suspicions, if not against the president herself, certainly against many of those who surround, or have surrounded, her (she is a former minister of energy in Lula’s government and a former chairman of the administration council of Petrobras.) So far, however, no accusations or evidence emerged against Rousseff. In fact, she does not even seem to be a major target of investigators, who seem to be zeroing in on Lula (and his immediate family.) The piece of accusation justifying the opening of impeachment proceedings relies on the use of accounting artifices to violate the constraints on public expenditure imposed by the Fiscal Responsibility Act, which a majority of opinion makers seem to consider too weak a case to sustain an impeachment. What makes the whole process more menacing is in fact her acute political fragility. Rousseff is universally seen as Lula’s creation, but never really relinquished his power over the party and the coalition it led.

Soon after Rousseff was reelected in November 2014, she announced a radical change of orientation in her administration’s economic policies. Austerity policies, cutting expenditures and raising taxes, seemed to be unavoidable in the face of the increased federal expenditure made to ensure her victory in the presidential elections.

The incumbent president repeatedly stated during the campaign that she rejected those policies, only to announce their implementation a few days after the result of the popular vote became known. Despite the apparent support of Lula, the change in orientation was badly received by the official Workers Party (PT), which grudgingly announced support for her, but conditioning it to a change in macroeconomic policies.

The party seemed to ignore the fact that during 2014, the increase in fiscal deficits failed to have any expansionary impact on the economy, which did not grow at all. The perception that the president had no political support of her own, however, stimulated her adversaries to aggressively advance proposals for her impeachment, based on whatever reason one could find, or the annulment of the election itself, or if nothing else worked, to force her to resign. With an aggressive opposition and unable to count on a supporting political base, the government was paralyzed for the whole year.

No relevant austerity measure has obtained Congress’ approval. Despite the effort of leftist parties to blame the pro-austerity Finance Minister Joaquim Levy for the contraction of the economy, it is impossible to ignore the fact that the failed attempts to get the proposed policies approved by Congress just made explicit the lack of political power that characterized Rousseff’s position. The impasse created by the inexistence of an effective government in the face of an aggressive opposition led decision-makers to postpone any but the most immediate decisions. Investment has fallen, workers have been fired in increasing numbers, consumption has been negatively impacted, etc.

The political crisis has transformed an expected recession into something that threatens to become a major depression, both in depth and duration. The situation is made more difficult by the difficulty to visualize any sustainable solution for the crises in the mediate horizon, let alone the coming months. If the impeachment process prospers, one could expect for sure increased political instability as a result, on the one hand, of attempts by PT and the social movements that are close to it to react somehow, and, on the other, by the fact that there is no organized opposition ready to take the place of the current administration. If the impeachment initiative is defeated, the problem remains that the president does not have any vision or power and it is overwhelmingly difficult to imagine how she could recover enough initiative to last the three remaining years of her term in office.

Paraphrasing the late historian Eric Hobsbawn, who observed that the Twentieth Century had been very short (beginning in 1914 and ending in 1991), 2015 may be a long year for Brazilians. The incompressible minimal duration of an impeachment process will take it to 2016, when the social situation may be more tense than it is now, with high inflation and increasing unemployment. If a national agreement of some sort, be it in terms of allowing Rousseff’s government to work or by removing it altogether, is not reached to avoid the worse, 2015 can last even longer. The country may dive into an unknown abyss of a combination of economic, political and social crises of which it is hard to see how, when and in what conditions it will recover.

(End)

Excerpt:

By Fernando J. Cardim de Carvalho
RIO DE JANEIRO, Aug 22 2015 (IPS)

As the political situation in Brazil appears to be reaching a state of unstable equilibrium, or more bluntly, as it is transformed from instability to impasse, the economy continues to deteriorate.

The sharpening of political conflicts that could lead to an outright collapse of the economy seems to have been attenuated by the shift on Apr. 7 of effective political power from President Dilma Rousseff to Vice-President Michel Temer.

Fernando Cardim de Carvalho

Temer was successful in bringing Renan Calheiros, the chairman of the Federal Senate, back to the government camp, in a power-sharing agreement meant to isolate the chairman of the House, Eduardo Cunha, who has assumed a much more radical stance. The arrangement has worked so far.

The pressure on the President to resign or on the appropriate bodies to give cause to initiate impeachment processes seems to have reached its limit. Popular opposition to the federal administration, which has its stronghold in Sao Paulo – as shown in mass demonstrations in March and April and most recently on Aug. 16 – has not seen the snowball growth its leaders expected.

In sum, positions seem to have been hardened as a measure of political accommodation has been reached, with the Brazilian Democratic Movement Party (PMDB) taking the lead on the side of government, and the formal opposition to government, including the nominally leading opposition party, the Brazilian Social Democracy Party (PSDB), rallying to the side of Eduardo Cunha, still their best hope on the way to an impeachment procedure.

Street demonstrations at this point seem to be unable to change this picture. Still, it should be noted that only the opposition has been able to organise large demonstrations. Attempts by pro-government groups to do the same in favour of the government have been few and largely unsuccessful.

In this context, as expected, the Brazilian economy continues to deteriorate. The contractionary impact of fiscal retrenchment has been greater than anticipated because not many people can foresee what will come next. In fact, no one can, even if announced measures will in fact be implemented while current difficulties, including fiscal difficulties, grow further.

The federal government was not able to pass the contractionary measures it argued to be essential, thus creating a ‘Catch 22’ situation in which one expects the success of the government to be very bad for the country but its failure to be even worse. Many economists are predicting a fall in 2015 GDP close to two percent, postponing chances of recovery until at least 2017.

“[Brazil] finds itself at an impasse. No political force seems to be strong enough, or even interested in finding a better and more promising alternative policy strategy”
If this contraction actually happens, it will be one the most serious recessions in recent history, much worse than what happened in 2008 and 2009.

The reasons for this are complex and the government is partly correct to point to the worsening of the external scenario. China can no longer carry Brazil forward. The recovery of the U.S. economy is weak and volatile. Europe is unable to overcome its own fossilised views on the virtues of austerity, causing the whole area to limp around.

Of course, this excuse only goes so far. Many analysts had called the attention of government authorities to the fact that growth during President Lula da Silva’s two terms in office (2003-2011) would vanish in the event that China lost its breath, as has actually happened.

The country lost the opportunity to make the investments, particularly in infrastructure, which could have increased its productive capacity. Efficient industrial policies should have been consistently implemented to that end, public investment should have been expanded, and consistent exchange rate policies should have been sought to change the picture of overvaluation that has been killing local manufacturing, on and off, since the Real Plan was implemented in 1994.

Practically nothing of this was effectively done. Investment plans were announced that had no consequence, local manufacturers became importers on an increasing scale, and roads, ports and energy production fell behind needs, while the government presented policies to increase household indebtedness to expand consumption as a successful combination of economic and social policies.

In the last two years of Rousseff’s first term (2011-2014), these policies were not even successful in increasing growth rates and GDP stalled as the government appealed more and more to tricks, particularly accounting tricks, and the distribution of favours to politically-connected sectors to try to revive the economy.

To a large extent, the turn to austerity was motivated by the failure to revive the economy, which doubled the bet on mistaken policies. Austerity measures in a shrinking economy can only accelerate the fall. But the dissolution of the political power of the president tripled the bet.

No one can believe that the president has the power to effectively pursue an alternative policy path. In fact, if the alternative to austerity is going back to what she did in her first term, the president will not find any supporters, except, perhaps, in her fast-shrinking number of hard-core believers.

So the country finds itself at an impasse. No political force seems to be strong enough, or even interested in finding a better and more promising alternative policy strategy. The more radical opponents – the Workers’ Party (PT) and the PSDB – got lost in a ‘blame game’, trying to pin down which of two presidents, Fernando Henrique Cardoso or Lula, had been worse.

None of them seems to have anything to offer. PMDB does not deal in wholesale strategies, it is more interested in retailing. Given the steep loss of trust in the PT or its leaders, including Lula, the party seems to be excluded from any power arrangement to be designed in the near future (its perspectives for the long-term future are at a minimum very uncertain).

The situation of the PSDB is not much better, because all it has in its favour is the receding memory of the Cardoso period, in which much the same problems were as serious as they are now and the party was as incompetent in pointing to solutions as the PT is now.

In this situation, the PMDB stepped in. It reached some measure of political stability but it has no vision of where to take the economy. Given its structure as a federation of state leaderships, the PMDB deals better with favours than with strategies.

As happened under President José Sarney in the late 1980s, this may be enough – in the best of circumstances – to put the brakes on economic deterioration but not to guide its revival.

The country will survive, of course, as it has done in the past.  The problem is that Brazil has experience of unfortunately all too frequent low-quality political leadership, so even the optimistic analysts can only see hardship ahead. (END/COLUMNIST SERVICE)

Edited by Phil Harris   

The views expressed in this article are those of the author and do not necessarily represent the views of, and should not be attributed to, IPS – Inter Press Service. 

Excerpt:

By Fernando J. Cardim de Carvalho
RIO DE JANEIRO, Apr 1 2015 (IPS)

Even moderately well-informed analysts knew that the Brazilian economy was in dire straits as President Dilma Rousseff initiated her second term in office in January.

Unlike her predecessor, Luiz Inácio Lula da Silva (2003-2011), Rousseff had not the same luck with the situation of the international economy. But also, unlike Lula, Rousseff showed herself a poor saleswoman for Brazilian goods and an even poorer manager of domestic economic policy.

Fernando Cardim de Carvalho

There was a strong suspicion that economic policy, especially in the last two years of her first term, had been conducted in ad hoc ways and that serious adjustments would be needed to steer the economy back to working condition anyway. Still, the situation seemed to be even worse than most analysts feared.

More surprising, however, is to find out that Brazilian politics is also in dire straits. Caught off guard by the Petrobras corruption scandal, federal authorities, beginning with Rousseff herself, seemed to become paralysed by the rapid fall in public support, completely losing the power of initiative and creating a dangerous political vacuum in the country.

It is a vacuum rather than a political threat because the opposition seems to be as lost as the president. The political right, never very fond of democratic institutions any way, seemed to be more interested in making the president “bleed” – as stated by Senator (and former vice-presidential candidate) Aloysio Nunes Ferreira, of the Brazilian Social Democracy Party – than with fighting for political hegemony.

Economic problems were certainly fostered by the quality of economic policy-making in the second half of Rousseff’s first term. The realisation that tailwinds created by the Chinese demand for raw materials were no longer blowing led the government to implement a series of measures to stimulate the economy that turned out to be largely useless.

It was not “heterodoxy” that characterised the policy, it was uninformed wishful thinking. A plethora of measures were taken in isolation, without any apparent unifying strategy behind them, distributed mostly as “gifts” from the federal government (which later contributed to the public perception that corruption became a system of government). “Brazil is living through a very dangerous period right now. Neither the government, nor the parliamentary opposition are led by leaders the population trusts”

Plagued by semi-structural exchange rate problems, whereby Brazilian producers lose competitiveness in the face of imported goods in domestic markets and of other sellers in international markets, the federal administration tried to deal with them piecemeal, mostly through instruments like tax reductions or changes in tax rates.

Obsessed with car production, the government burned resources trying to stimulate production (only to meet increasing resistance of other countries to import them, most notably Argentina), again without any strategy thinking about how these newly-produced automobiles would be used in polluted and traffic-jammed Brazilian cities.

The federal government was not deficient only in terms of strategic thinking but also in terms of home caretaking: all available evidence points to the high probability that tax reductions and other similar measures were decided without any calculation of costs, lost fiscal revenues, and so on.

Anti-cyclical macroeconomic policy in late 2008 relied to a large extent on the expansion of consumption expenditures fuelled by increasing household indebtedness. The increase in non-performing loans and income stagnation made this option more and more unsustainable. Investment, in contrast, public and private, repeatedly frustrated expectations.

Unable to finance badly needed infrastructure investments, the government showed itself to be extraordinarily slow in devising appropriate strategies to attract private investors to implement them. Apparently lost in their own inability to define a way out of the mess, the government “muddled through” situations where more forceful definitions were required, as was the case of electric power.

The list of failures or of situations where the government showed inability to lead is long and well known. What was surprising to some extent was to find out that all evidence suggests that the government itself was unaware of what was going on.

Winning re-election by a narrow margin, President Rousseff, characteristically after a long period of hesitation, decided to take a 180-degree turn, asking a known orthodox and fiscal conservative economist to head an empowered Ministry of Finance, surprising even her supporters who seemed to be perplexed by the need to defend policies that they hotly denounced when presented by opposition politicians.

This picture would be difficult enough to manage without the Petrobras scandal. But Petrobras is not only the largest company in the country, it is practically a symbol of the nationality. Besides, energy was supposed to be Rousseff’s area of expertise and she was in fact responsible for the company’s policies for a while, as Minister of Mines and Power.

An increasingly loud murmur of a possible impeachment of the president led her to equivocal political decisions, beginning with the definition of her cabinet, widely considered to be particularly low quality, and alienating not only her major party in government, the Brazilian Democratic Movement Party, but even the majority of her own Workers’ Party.

The result of such initiatives was illustrated by the twin public demonstrations of Mar. 13 and 15.

On Mar. 13, nominal supporters of Rousseff marched through the streets of most of the largest cities in the country. Speaking to the press, most of the leaders of the march (Lula did not participate) declared conditional support for Rousseff – that is, conditional on the firing of the Minister of Finance and change of newly announced austerity policies.

On Mar. 15, an even larger crowd marched in the same cities declaring unconditional opposition to the president.

Brazil is living through a very dangerous period right now. Neither the government, nor the parliamentary opposition are led by leaders the population trusts. The president is slow and generally equivocal when making fateful decisions. The right-wing opposition seemed to be more interested in enjoying the possibility of enacting a “third” ballot to obtain at least a moral condemnation of the president.

This would be bad enough for a country that has just celebrated thirty years of civilian government. When the economy adds its own heavy problems to the political vacuum, it is impossible not to fear the future. (END/IPS COLUMNIST  SERVICE)

Edited by Phil Harris   

The views expressed in this article are those of the author and do not necessarily represent the views of, and should not be attributed to, IPS – Inter Press Service. 

Excerpt:

By Fernando J. Cardim de Carvalho
RIO DE JANEIRO, Oct 30 2014 (IPS)

The tight race between incumbent President Dilma Rousseff of Brazil’s Workers’ Party and her opponent, Aecio Neves from the centre-right Brazilian Social Democracy Party (PSDB) party, ended on Sunday, Oct. 26 with the re-election of Rousseff.

As happens in cases of re-election, the new government is, for all purposes, inaugurated immediately, because there is no need to wait until the legal date of January 1 to begin forming the new government and making necessary decisions.

Fernando Cardim de Carvalho

Neither is there a honeymoon in a re-election: voters expect work to begin and some results to show right away.

There is no doubt that Rousseff faces a difficult period ahead. The economy has ground to a halt during 2014 and the perspectives for 2015 are not much better. During practically the whole of the first semester, inflation remained near or above the ceiling of 6.5 percent that was set by the government itself, and the perspectives for next year are not good either.

Balance of payments positions are not comfortable, marked by very high deficits in current transactions and dependence on capital inflows. Social inclusion programmes that were very successful in the recent past may be near exhaustion and will need an upgrade.

Finally, a huge deal was made during the electoral campaign of corruption cases in the administration and in state enterprises, notably Petrobrás, the Brazilian oil company, raising issues that will have to be dealt with by the incoming administration.“There is no doubt that Rousseff faces a difficult period ahead. The economy has ground to a halt during 2014 and the perspectives for 2015 are not much better”

This does not address, of course, another set of difficulties related to the formation of governments in the Brazilian political system, requiring coalitions to be formed with political parties that look like being for rent rather than available for political debates around principles or programmes.

Let us be clear: the situation is uncomfortable on many fronts but is far from catastrophic, no matter how dramatic opposition speeches have tried to suggest.

Things are far better than in Western Europe, for example, where a second recession is very likely to happen in the near future in economies already devastated by the irrational adherence to austerity policies imposed by some governments led by Germany. But the problems the new government will have to face cannot be underestimated either.

Focusing only on the economic challenges, Rousseff’s first task is to try to escape the curse the Brazilian economy has been facing since it achieved control of inflation twenty years ago.

The Real Plan, named after the new currency that was introduced in 1994, was based on the access to cheap imports obtained by liberalising foreign trade and an overvalued currency. To maintain overvaluation it was necessary to attract foreign capital inflows, which required high interest rates (higher than that paid in other countries). High interest rates were also necessary to control domestic demand so that no significant pressure would be applied on domestic prices.

However, exchange rate overvaluation and high interest rates reduced the competitiveness of local producers, particularly in the manufacturing sector, which are very sensitive to exchange rate behaviour.

As a result, the Brazilian economy has lived on a see-saw in these twenty years, alternating periods where devalued exchange rates have allowed some industrial expansion at the cost of accelerating inflation with periods of controlled inflation at the cost of industrial stagnation.

Fernando H. Cardoso was imprisoned by this dilemma, as was Lula da Silva. So was Rousseff in her first term, when she, to her credit, realised that the country had to escape the trap but was unsuccessful in finding the way to do so.

With the international economy in a weak condition, and which is forecast to last, Rousseff has to find a way to promote growth without fuelling higher inflation and increasing external vulnerability, that is, without raising the volume of imports when exports are stagnating.

Bringing the inflation rate down is also needed. Societies tend to have long memories (see how the Germans still react to the hyperinflation they experienced a century ago). A large number of Brazilians still remember how unbearable life was when inflation was in the two-digit figures a month.

We are not anywhere close to repeating that experience, but it has made Brazilians alert and sensitive to any signs that government may be lax in fighting inflation. Besides, 6.5 percent a year for more than three years in a row does add to significant loss of purchasing power for fixed incomes and for those wages and salaries that are not compensated by more generous increases.

Even the greatest triumph of the Workers’ Party administration – social programmes – may be near exhaustion.

The Food and Agriculture Organization of the United Nations (FAO) has announced that hunger is no longer an issue for Brazil. Of course, this is great news but it also means that social policies will now have to be designed with higher aims, to improve the quality of life for the populations that were upgraded by past programmes.

Jobs, education and health are much more difficult to address than extreme poverty, the reduction of which could be dealt with cash transfers. Even if no other important problem was on the agenda, this is a tall order for any political leader, but it is even more so for a re-elected president.

Brazilian citizens are impatient to see how Rousseff will meet the challenge. (END/IPS COLUMNIST SERVICE)

(Edited by Phil Harris)

The views expressed in this article are those of the author and do not necessarily represent the views of, and should not be attributed to, IPS – Inter Press Service. 

Excerpt:

By Fernando J. Cardim de Carvalho
RIO DE JANEIRO, May 20 2014 (IPS)

Brazil’s real gross domestic product (GDP) in 2013 grew by 2.3 percent, following rates of 2.7 percent and 1 percent in 2012 and 2011 respectively. Perspectives for 2014 on this front are not optimistic.

Meanwhile, annual inflation has remained stubbornly high, at around 6 percent, and the balance of payments position has been less than comfortable, with increasing deficits being recorded in its current account (exports of goods and services less imports).

The silver lining comes in the labour market, where not only practically full employment has been maintained, but the quality of jobs seems to be holding up, with workers shifting from the informal to the formal markets, where they qualify for benefits such as unemployment compensation and pensions.

Fernando Cardim de Carvalho

Only a few years ago, together with its BRICS partners (Russia, India, China and South Africa), the Brazilian economy was hailed as the new frontier of growth in the international arena. Today, gloomy projections are routinely issued by international institutions and domestic expectations seem to remain subdued. What could possibly have happened to change the picture so dramatically in such a short time?

The roots of the present economic situation seem to be a complex combination of international difficulties, not-so-competent policy-making and random misfortunes. In addition, recent political evolution has contributed to complicate matters even more.

Taking each factor at a time, the most visible difference with the performance of the Brazilian economy during current president Dilma Rousseff’s first term of office relates to the international environment. During President Lula Da Silva’s second term (2007-2011), the Brazilian economy benefited from tail winds represented mostly by strong Chinese demand for raw materials and agricultural goods, which not only helped the country to maintain a comfortable position in its balance of payments but also pushed its domestic economy strongly upwards.

This era seems to be over, given the publicly expressed concerns of the current Chinese government to cool and reform its own economy. The cooling of exports growth has helped to highlight one “structural” problem of the Brazilian economy, particularly strong after high inflation was defeated in 1994.

"The inability to define strategies to insert the Brazilian economy in a world economy going through deep changes has been a permanent feature of post-democratisation governments..."
Since that time, with short intervals in which the trend was temporarily broken, an overvalued domestic currency has been perhaps the most powerful tool to keep inflation under control. The possibility of importing goods at prices made low by a strong domestic currency not only provided domestic markets with cheap goods but also scared local producers into avoiding raising their prices and losing their markets to imports, a force particularly strong in the manufacturing sector.

This means that since the Real Plan in 1994, Brazil has been captured by a well-known dilemma: inflation can be kept low by overvaluing the domestic currency or manufacturing growth can be sped up by devaluing the currency, but one does not know how to achieve both. As a result, the Brazilian economy has been plagued by periods of intense “deindustrialisation” (when the currency is overvalued) or by inflationary pressures (when the currency is devalued).

While the Chinese economy was growing fast enough to carry raw materials exporters like Brazil, overall growth could be kept by substituting growth of exports for growth of manufacturing. But the recent deceleration of Chinese growth has made the dilemma faced by the Brazilian economy explicit.

The strong dependence of the international economy has been a major feature of the last twenty years and the weakening of international trade has made the limitations that define current policy-making more dramatic than ever. Unable to change the terms of the trade-off opposing a higher inflation rate (by allowing steeper currency devaluations) to higher growth rates, particularly of the manufacturing sector (by allowing the real to get stronger), Rousseff’s government has appealed to ad hoc policies that not only have not had the expected effect but, on the contrary, have created new problems.

As an example, unable to implement a coherent exchange rate policy to stimulate domestic manufacture, the government has conceded targeted fiscal relief to selected sectors. This strategy, if one can call it that, is of very limited efficiency. Benefits are temporary, generally given to help sectors to go through difficult periods. They do not signal market priorities, they just help some firms to get by. They cause state revenues to fall but do not stimulate investments or expansion of production, let alone technical progress or increase of productivity. Businessmen learn that it may be more profitable to lobby for favours than to invest and increase productivity. The fall in revenues leads to increased political pressure from believers in “austerity”, often forcing the government to cut other expenditures, which could be more effective but would require a longer period to mature. Necessary public investments are always the adjustment variable.

The inability to define strategies to insert the Brazilian economy in a world economy going through deep changes has been a permanent feature of post-democratisation governments (that is, since the mid-1980s) and it may be partly due to the realities created by the way the political system, and particularly the party system, was reconstructed after the military went back to the barracks.

Finally, one has also to acknowledge that bad luck has also had a hand. Bad weather, in the form of a particularly nasty drought, has affected the production of food and the generation of electric power, in a country where hydropower is by far the most important source of electricity. This has not only kept inflation pressures up but has also clouded the future, making firms even warier of investing.

In sum, it is not a comfortable time for the Brazilian economy. That important elections are also coming up in October this year does not help because the political debate tends to polarise, so that nobody expects important decisions to be made this year. This means that things should not improve significantly before 2015 at the earliest. (END/COPYRIGHT IPS)

Excerpt:

Quantitative Easing (QE) has been favourable to developed countries, stimulating local investment and exports. Credit: Bigstock.

By Fernando J. Cardim de Carvalho
RIO DE JANEIRO , Jun 25 2013 (IPS)

It took world leaders some time to realise that the financial crisis initiated by the collapse of the subprime mortgage segment of U.S. financial markets in 2007 would not exhaust its effects in an ordinary recession.

For most of 2007 and 2008, government authorities, especially in the U.S., argued, rightly, that subprime mortgages were a relatively small segment of the U.S. financial system, concluding – wrongly, as it turned out – that the crisis could be easily contained through the use of conventional policy instruments at the disposal of the Treasury and the Federal Reserve.

In fact, the crisis spread out to other segments of U.S. financial markets and, in September 2008, with the bankruptcy of Lehman Brothers, it spread out to most of the rest of the world.

As domestic financial sectors in the countries hit by the shock waves were engulfed by their own crises, credit supply contracted and the financial crisis was transformed into an economic crisis, with falling output and rising unemployment.

The realisation that the crisis was deeper than most analysts expected initially led governments to react through implementation of anti-cyclical macroeconomic policies. Expansive fiscal and monetary policies were implemented, in one form or another, not only in the U.S. and Western European countries, but also in many developing economies in 2008 and early 2009.

The collapse of output and employment in the developed economies was contained and the ghost of a disaster like that of the early 1930s was, at least temporarily and at least for some countries, exorcised.

At this point, economic policy debates in the richest economies suffered a reversal.

Output was still lower and unemployment much higher than before the crisis both in the U.S. and in Europe. Nevertheless, the debate switched from real problems to fiscal balances. Conservative groups, ranging from the lunatic extreme right of the Tea Party in the U.S. to the moralising posture of northern European governments led by right wing parties or coalitions, prevented the further use of fiscal policy to raise output and to create jobs.

It is a fascinating discussion as to why this happened, but there is no room in this commentary to explore the question. The fact is that aggressive expansionary fiscal policies have become politically unacceptable even while output is low (or even falling, as is the case with many European countries, and not only the “peripheral” ones) and unemployment is growing. Under these conditions, the only instrument left to try to increase market demand and to stimulate production was monetary policy.

Monetary policy, traditionally, impacts the economy through variations of interest rates. The interest rates under the control of monetary authorities like the U.S. Federal Reserve or the Bank of England, for instance, were, however, already very low, near zero.

There was not much conventional monetary policy could do to compensate for the lack of a rational expansionary fiscal policy. It was in this context that quantitative easing (QE) policies were formulated in the U.S., U.K. and more recently in Japan, while the European Central Bank struggles with itself to determine what should be its policy. QE policies are simply initiatives to funnel money into the economy in amounts great enough to facilitate the expansion of the supply of credit for private borrowers, both firms and consumers.

It may be too soon to assess whether they worked as expected or not. Of course, the developed economies where these policies were implemented are still struggling with the crisis and its developments. A generous reading of these policies is often based on a counter-factual: things are not that good yet, but they would be much worse if those policies had not been applied.

For developing economies, the impact is certainly ambiguous. On the one hand, accepting the assumption that without QE policies developed countries would be in a much worse situation than they are now, it is better than nothing.

If output had contracted further in those economies, trade would be even lower nowadays, creating balance of payments problems for many developing countries.

On the other hand, from the point of view of developing countries, monetary easing is certainly not the ideal way to support output and employment.

QE increases money supply at the same time that it reduces domestic interest rates in the developed economies. In a world of free capital flows, as is mostly the case now, this means that a large part of this liquidity will flow out of the country that created it.

In part, although governments deny it, this is precisely what they expect: capital outflows devaluate the currency of the country practicing QE, so it will have two stimuli for the price of one: lower interest rates stimulate domestic production and investment, and devalued currencies stimulate exports.

Of course, for developing countries the impact is exactly the opposite: they receive too much foreign liquidity, their exchange rates tend to become overvalued, reducing exports and stimulating imports.

Deficits in the balance-of-payments current account tend to emerge, but it is easy to finance them since there is so much liquidity in the world.

Until, of course, QEs are discontinued and borrowing countries will find out, as they did many times in the past, that foreign debt accumulated to the point of leading them to a crisis.

Would it be better not to have developed countries practicing QE? Well, governments in these countries had to do something and monetary policy was the only instrument left after right wing parties prevented them from using fiscal policy.

Expansionary fiscal policies in those countries, however, would be much better for developing economies because they expand their domestic economies without undervaluing their currencies. Fiscal expansion, in contrast to monetary expansion, is not a beggar-thy-neighbour type of policy.

There is evidence now that the Federal Reserve expects to stop QE3 relatively soon. QE had some deleterious impacts on developing countries, as just argued, but its reversal is also full of risks.

It is possible that interest rates will rise too much and too quickly, creating serious problems for those countries and firms that borrowed more in this period.

Increased volatility itself, because of the uncertainties such a change in direction engender, is a problem, scaring investors and depressing production and investment. To expand the economy to get out of a depression is the correct attitude, but QE was an instrument that definitely contributed to increased short and medium term risks of the macroeconomic situation.

(END/COPYRIGHT IPS)

Excerpt: