OF SUBSTANCE AND SPIRIT
By DIWA C. GUINIGUNDO
Diwa C. Guinigundo
It was Edward P. Lazear of Stanford University (2011) who argued that “Lehman was not the domino that toppled the others. But our financial crisis was caused by factors that affected the entire system, just as all corn kernels pop when they are warmed by the same flame.”
It has been more than ten years after the Global Financial Crisis. Its lessons remain extremely useful to interpret what is now unfolding in the global economy.
This is the big and bleak picture: a synchronized economic slowdown in both advanced economies and emerging economies is expected. International financial institutions like the IMF, ADB, and ASEAN + 3 Monitoring and Research Office based in Singapore downgraded their previous forecasts of global economic growth.
This global slowdown will affect everybody, even if in varying degrees.
The probability of output performance of less than 2.5 percent for 2019 has increased from 7.6 percent in the Fall of 2018 to almost 9 percent during the Fall of 2019. National economies are corn kernels subjected to a shared heat. Corn kernels that pop are the Zea mays everta.
Major heat emanates from US and China trade tensions. While the effects could be mitigated since in the short run, there could be trade and investment diversion from China to some Asian countries like Cambodia, Indonesia, Philippines, and Vietnam.
This diversion may assuage the adverse consequences of the US’ imposition of higher tariffs on Chinese exports, including products of American China-based corporates. The balance and offsetting effects of these tempering factors; the negative impact from lower exports; and any disruption in the global value chain are keys in “heat control.”
Heat could also emanate from lower productivity growth among ASEAN + 3 countries such as China, Indonesia, Korea, Malaysia, the Philippines, and Thailand.
Many economies are now challenged by aging demographics and infrastructures. According to the 2019 Productivity Brief of the Conference Board Total Economy database, while productivity slowdown has bottomed out, there are yet no clear signs of recovery.
Negative sentiments following the swordplay between Washington and Beijing, Brexit, the attack on Saudi Arabian oil wells, the turmoil in Chile and Hong Kong are likely to result in lower productivity posing a significant drag to global growth. Investment and business sentiments are dampened in the face of these volatile situations.
Elevated global economic policy uncertainty adds more heat. If the market continues to speculate on the direction of public policy, lower investment and production will aggravate an already unfolding global slowdown. This is another source of heat that would affect all corn kernels in the global pot. Weaker and more vulnerable kernels, those with moisture in them, would be the first to pop.
The domino effect does not apply. Keith Hennessey and Lazear (2013) explained: “The fundamental cause of the problem for other institutions cannot be alleviated by treating the first institution that fails. Contagion was a factor (only) in a few significant specific cases.”
One cannot isolate a weak economy to prevent the spread of the shock. As long as the heat persists, corn kernels would succumb to pressure and pop.
I believe that the problems must be addressed head on.
For economies to sustain their easing mode, monetary or otherwise, appropriate and ample space should exist.
Boston Fed President Rosenberg in his five-point guidepost advises that “despite risks to growth, policymakers can afford to be patient and evaluate incoming data before further cutting interest rates. Right now, more cuts don’t appear needed.”
Aggressive monetary easing could encourage mispricing of risks; encourage further leverage and invariably search for yields at the time that the cycle demands lower interest rates. If fiscal space exists, and macro-prudential measures are not overextended, more aggressive public spending should be resorted to, and macro-prudential tools should be harnessed.
Sustained structural reforms remain imperative. There is greater need for combined action when corporate debt burdens are rising; holdings of riskier and more illiquid assets are higher; and there is more reliance on external borrowings.
Whether these conditions obtain in the Philippines deserves closer and more careful assessment. Care against any unintended consequences such as financial imbalances must temper pro-growth policies so that the momentum is sustainable.
Moreover, during discussions at the IMF World Bank annual meetings, as well as in various international conferences and academic gatherings on monetary policy, there have been observations of a possible flattening of the Phillips curve.
When this happens, inflation becomes less responsive to movements in aggregate economic activity. A flatter Phillips curve implies that a slightly higher output gap, and lower unemployment may not necessarily be inflationary. With a declining slope, a flatter Phillips curve means it would be more challenging for monetary policy to arrest inflation once it becomes entrenched.
Admittedly, at this point, many emerging markets do not have to contend with excessively low interest rates or the so-called zero lower bound. In the Philippines, nominal policy rates are higher than domestic inflation and the financial sector remains secure.
This notwithstanding, press coverages both here and abroad highlighted the IMF’s observation of easy monetary policy in the Philippines and in other similarly situated emerging markets.
A careful reading of the Foreword of the same October 2019 World Economic Outlook would show that the Fund itself also warned: “With central banks having to spend limited ammunition to offset policy mistakes, they may have little left when the economy is in a tougher spot.”
As the precarious global scenario unfolds, it is becoming clearer that the shocks are indeed global. Therefore, both advanced economies and emerging economies are not proverbial dominoes at this time. They are more likely to be corn kernels that will pop when the heat elevates some more.