IMF Warns Western Economies Mired in 'Near Depression'

Monday, 04 Oct 2010 08:12 PM

By David A. Patten

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A new report by the International Monetary Fund paints a brutally grim picture of the global economic outlook, warning that continued European belt-tightening combined with possible deficit-cutting in the United States could lead to a global double-dip recession.

Ambrose Evans-Pritchard, international business editor of the Daily Telegraph newspaper, wrote that the report suggests Western economies are stuck in a "near depression."

In the near term, the report suggested, nations seeking to stabilize their economies by cutting their budgets will only make the global economy worse.

Evans-Pritchard reported the IMF analysis "more or less condemns southern Europe to death by slow suffocation and leaves little doubt that fiscal tightening will trap North Europe, Britain, and American in a slump for a long time."

Nobel Prize-winning economist and former World Bank chief economist Joseph Stiglitz used even more drastic imagery. He said some governments may be caught in a "death spiral."

Stiglitz warned that Spain, which has a ballooning deficit and massive unemployment, may be the next target of the same speculators who pushed Greece to the brink of insolvency earlier this year.

"Under the rules of the game, Spain must now cut its spending, which will almost surely increase its unemployment rate still further," Stiglitz wrote. "As its economy slows, the improvement in its fiscal position may be minimal."

Moody’s last week cut Spain's credit rating from AAA to Aa1.

Entitled "Will It Hurt? Macroeconomic Effects of Fiscal Consolidation," the IMF report states that when a nation cuts its budget by 1 percent of GDP, it ordinarily experiences a half percentage point drop in growth.

But if interest rates are already at zero -- as is the case now in many nations -- and too many nations cut their spending simultaneously, the negative impact of austerity programs on economic growth can be much worse.

The report stated that cutting government spending does help economies to grow in the long run. But first come slower growth and higher unemployment, at least as far as the current "fiscal retrenchment" is concerned.

The United States responded to the economic meltdown by opening its wallet wide and doling out over $1 trillion in TARP and stimulus spending, a significant percentage of which flowed overseas.

European nations, on the other hand, took a much more conservative approach, and rebuffed President Barack Obama's entreaties for them to spend more money in order to juice their economies. Recently, they have begun to embark on serious cost-cutting campaigns.

The latest example came Monday, as British Chancellor of the Exchequer George Osborne's announced that some 3 million wealthy British families will no longer receive the stay-at-home mom benefit. That entitlement paid those with two children up to $2,700 a year.

Portugal, meanwhile, is in dire economic straits. Premier Jose Socrates is increasing the VAT tax, cutting public-sector wages, and freezing pensions. Portugal's trade unions have called for a massive strike next month.

The IMF's concern is that too many nations tightening their belts at the same time will lead to economic stagnation, before the longer-term benefits of smaller public sectors take effect.

Stiglitz, a Columbia business school professor who argues for a return to Keynesian economics, is promoting an updated version of his book "Freefall: America, Free Markets, and the Sinking of the World Economy." He warned in the Telegraph that the Euro might not survive the Continent's current austerity crusade. He said its outlook appears "bleak."

"The worry is that there is a wave of austerity building throughout Europe and even hitting America's shores," Stiglitz wrote. "As so many countries cut back on spending prematurely, global aggregate demand will be lowered and growth will slow -- even perhaps leading to a double-dip recession."

In the United States, analysts are nervously awaiting Friday's September unemployment report.

With less than a month before the November midterms, that report will receive heavy scrutiny as an interim report card on the U.S. economy. Most pundits expect Obama to face a much more austerity-minded Congress following the election.

One major wild card: How will voters interpret Democratic leaders' unwillingness to extend the Bush tax cuts? House Minority Leader John Boehner said so many Democrats crossed over to join with Republicans on extending those tax breaks that the House could have passed an extension. But House Democrats refused to bring the measure up for a break before sending the members home for recess.

Also Monday, some members of the president's own economic recovery board appeared to break with him over the Bush tax cuts.

The unusually frank exchange between the president and his advisory board involved Harvard economics professor Martin Feldstein, who was chairman of President Reagan's Council of Economic Advisers, and former SEC chairman William Donaldson.

Without extending the tax cuts, they argued, a climate of economic uncertainty would continue to plague businesses, they said, discouraging them from hiring new workers. But Obama refused to back down.

Obama's response according to Politico: “I don’t know any economists -- including, I think, Martin -- who think we are likely to get a bump in aggregate demand from $700 billion of borrowed money going to people like those of us around the table, who, if I suspect want a flat-screen TV, can afford one right now and are going out and buying one.

Obama also stated: “If we were going to spent $700 billion, it seems, we’d be wiser having that $700 billion going to folks who would spend that right away.”

ABC News' Political Punch blog reported that Feldstein said extending the Bush tax breaks for some Americans, but not for others, would send a bad signal.

Obama's blunt response: "They have to pay slightly higher taxes. That's the signal."

Despite the current 9.6 percent unemployment rate, the president appeared to enjoy his feisty exchange with the economists.

“This was a fun conversation; it went a little off script, which is good,” Obama told the advisory board. “I liked it. I enjoyed it.”

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