Center for Financial Markets and Policy Conducts Capitol Hill Briefing

September 30, 2011

The Center for Financial Markets and Policy at Georgetown’s McDonough School Business co-hosted a Capitol Hill Briefing Sept. 20, 2011, on the top global risk factors facing the international economy.

Jay Shambaugh, former chief economist at The White House Council of Economic Advisors and current visiting associate professor of strategy at Georgetown McDonough, joined moderator Reena Aggarwal, Georgetown’s Robert E. McDonough Professor of Business Administration and Professor of Finance, and Bradley Belt, senior managing director at the Milken Institute, which co-hosted the discussion.

The panelists discussed seven pressing global economic issues, raising concerns and potential policy prescriptions that have lacked appropriate media attention and inclusion in ongoing national debate.

First, in response to Aggarwal’s questions regarding the health of the American economy and the global impact of a domestic slowdown, Shambaugh noted that he did not think that the U.S. would enter a double-dip recession, though he added that a shock to the global financial system could alter that calculus and result in grave consequences for the international economy.  Shambaugh based his economic outlook, in part, on the unemployment rate, which as a reliable forward-indicator has recently signaled slow—though not negative—economic growth. 

Shambaugh added that while strong business investment and U.S. export activity have helped drive economic growth and stave off contraction, weakness in housing, structures investment, state and local government spending, and consumer demand have continued to weigh heavily on the economy.  Shambaugh and Belt agreed that increased household savings rates were a rational response to deleveraging household debt and that consumer demand would only increase as more Americans return to work or incomes grow at an appreciable rate.  Belt added that recent comments from Fed Chairman Ben Bernanke regarding his surprise that Americans were not willing to spend more demonstrates a troubling disconnect from the real economic challenges facing American families.

Second, Aggarwal raised the issue of how to encourage corporate America to put to productive use the significant levels of cash accumulating on corporate balance sheets.  She suggested that general regulatory and policy uncertainty were inhibiting use of these funds for investment.  Shambaugh suggested that another impediment to corporate investment was uncertainty surrounding the direction of consumer demand.

Third, discussion shifted to the European crisis, where Shambaugh noted that this was now potentially Europe’s ‘Lehman moment,’ particularly as inter-bank lending tightens due to uncertainty over which entities are exposed to at-risk sovereign debt.  Unlike at the height of the U.S. financial crisis, where regulators promoted transparency by assuming that certain financial instruments were essentially valueless when conducting stress tests, the Europeans thus far have not been willing to acknowledge the likelihood of a sovereign default and related necessity of marking-down the value of sovereign debt-holdings.  Shambaugh concluded that it would take a pan-European solution and significant political will to recognize that Greece would not be able to pay back its debt in full and that a European-based recapitalization of banks coupled with an orderly restructuring of Greek national debt was necessary.  Continued short-term loans to at-risk sovereigns would only kick the can further down the road.  Belt echoed Shambaugh’s concerns about Europe and noted that the status quo was unsustainable, suggesting that the EU was effectively left with two options —either pursue fiscal union or risk dissolution.

Fourth, Aggarwal raised the potential positive role the BRIC countries could play in global economic recovery.  Shambaugh agreed that BRIC offers to purchase European sovereign debt would be a positive symbolic action, but that their maximum effectiveness would come from backing IMF involvement in the European crisis through national contributions.  This would enable leveraged support of a pan-European bank recapitalization.

Fifth, Shambaugh turned to the impact of global austerity initiatives that were sharply curbing public spending.  He was alarmed that many nations appeared to be simultaneously ending stimulus programs, and in some cases substantially cutting baseline spending, thus reducing overall global growth. Some countries like Greece and Portugal had no choice, but Shambaugh questioned the wisdom of cutting spending in countries with a sound fiscal footing, like Germany. 

Similarly, in the short term, Shambaugh suggested that the U.S. employ fiscal stimulus measures to reduce unemployment and increase growth, so long as these spending measures were coupled with credible medium and long-term deficit reduction plans. 

Sixth, Shambaugh agreed with Aggarwal’s concern that commodity prices would serve as a continued threat to global economic growth.  While oil is down from its recent peak, Shambaugh noted that nominal spending on gasoline increased dramatically earlier in the year and effectively cannibalized billions of consumer dollars that could have been spent in other sectors of the economy.  He added that there is concern that any future uptick in global growth will be muted by parallel spikes in commodity prices.

Finally, Belt raised a concern regarding new asset-bubbles in the global economy, citing as an example China’s housing market.  He noted, for example, that Beijing’s housing prices had increased by 800 percent since 2003 and that the housing sector accounts for a greater share of China’s GDP than was the case in the U.S. before the housing bubble burst.  Shambaugh echoed concerns about the potential for a new asset bubble to trigger financial difficulties, but suggested that the fundamentals of the Chinese mortgage market, including larger equity requirements, reduced the likelihood that a downturn in the Chinese housing-market would reverberate around the globe. 

Ultimately, none of the panelists were optimistic about the near-term outlook for the global economy.  However, additional prescriptions to increase global economic growth will be discussed at next month’s  Hill Briefing on ‘Strengthening the Economy: Policies to Boost Growth and Job Creation.’