/6 Talking Business Nouriel Roubini – Résumé Present Roubini Global Economics, co-founder and chairman New York University’s Stern School of Business, professor of economics Crisis Economics: A Crash Course in the Future of Finance to be published by Penguin (2010) 1998 - 2000 White House Council of Economic Advisors, senior economist for International Affairs US Treasury Department, senior advisor to the Under Secretary for International Affairs Dr Roubini has published more than 70 policy papers on international macroeconomic issues and co-authored Political Cycles: Theory and Evidence (1997) and Bailouts or Bail-ins? Responding to Financial Crises in Emerging Markets (2004). He holds a PhD in economics from Harvard University. the markit magazine – Winter 2010 Talking Business /7 Nouriel Roubini, the US economist, believes quantitative easing is a necessary evil and that crises are becoming more frequent and damaging Crisis? Which crisis? Q: Since the start of the global credit crisis, governments I think recent opposition to QE2, especially those that around the world have injected an unprecedented have said it is a disaster, is totally wrong. Given the high amount of liquidity into the global economy. The risk of a double dip recession, ask yourself where would initial experience of quantitative easing suggests that the economy and risky asset prices be today if this had the increase in liquidity is positive for risky assets. not been done. Asset price reaction had already priced in However, the impact on the real economy is less QE2 from Bernanke’s speech in Jackson Hole well ahead clear. Do you think it has been effective in stimu- of the actual implementation. The stock market is about lating growth or should the Federal Reserve be taking 10 per cent higher. another approach? Roubini Global Economics wrote a paper concluding that another round of QE was appropriate; we even got A: Economic growth in the US and most developed econo- the $600bn estimate correct a couple of weeks before the mies is anaemic and below expectations. Measures of announcement. Unfortunately, the real economic effects inflation, both core and headline, are below the implicit and of this move are going to be modest at best. QE2 should explicit targets of the Federal Reserve. The scenario is low push industrial output next year from the baseline by only growth, low inflation and an unemployment rate close to about 0.2-0.3 per cent. We believe that potential growth 10 per cent. If one were to run the numbers, you get that should be about 3 per cent and the baseline is 2 per cent. the Fed Funds rate (FFR) should be around minus 5 per We also believe that 2.2-2.3 per cent growth is still below cent, but nominal policy rates have a zero lower bound. potential and thus there will still be deflationary pressure. Quantitative easing (QE) by the US and other governments The unemployment rate, when you include the under- has been increasing liquidity to effectively push the real employed, is effectively 17 per cent. The recent increase policy rate below zero. Some $600bn of additional liquidity of 150,000 jobs is not truly good news; it is only sufficient in QE2 is the equivalent of a reduction of about 50-60 to match pace with new entrants into the job market and basis points in the FFR. When Ben Bernanke says this is to prevent the unemployment rate from going higher. It just a variant of traditional monetary policy, I think that is does not bring it down. Labour has no bargaining power; correct, even if unconventional. if anything, employees are accepting lower wages just Winter 2010 – the markit magazine /8 Talking Business “ The concern about QE2 causing inflation is nonsense. How can you have inflation when there is such a slack in resources?” to keep their jobs. Wages are growing less than produc- 6 per cent without proper guidance, so the markets expe- tivity and unit labour costs are falling. With labour costs rienced a shock. The Fed learned that lesson. As long as it comprising 70 per cent of production costs, this is essen- makes its intentions clear and takes a measured approach, tially fiscal deflation. exiting can be done properly. We should fight the wars of the The concern about QE2 causing inflation is nonsense. present and not the ghosts of the future. How can you have inflation when there is such a slack in resources? Base money has more than doubled in the Q: What is your assessment of the austerity measures US but M1, M2 and M3 credit growth is negative because that many European countries are taking to tackle banks are hoarding money. Regardless of the reasons, their deficit troubles? banks are not lending. Thus, there is no multiplier effect and it is not inflationary. If banks have not lent the first trillion A: Currently, every advanced economy is running a fiscal dollars of QE1, why would they lend in QE2? This is why the deficit which is eventually unsustainable. In the fourth real effect is limited. While I am not particularly sympathetic quarter of 2008 and the first quarter of 2009, global to QE2, it should reduce the tail risk and help prevent a economic activity was falling at a faster rate than between double dip. Quantitative easing is a necessary evil. 1929 and 1931. Massive fiscal stimulus in the form of payments, tax cuts, etc. reversed the freefall. Fiscal Q: Many governments have indicated a strong desire stimulus was necessary to avoid a depression. To save to begin removing some of that liquidity but have yet Main Street, the government had to bail out Wall Street, no to do so in a meaningful way due to concerns about matter how unpleasant that may be to the public. I am the deterring economic growth. What conditions do we first one to be critical of some of the excesses of those bail- need to see before the Federal Reserve can start to outs, but those who argue that we should have let destruc- remove liquidity? Do you think the conditions and tion take place by leaving things to market forces are timing are similar for the European Central Bank? misguided. Without intervention, there would have been a great depression. The rational thing to do today, assuming A: I think there will be more liquidity increases − after QE2, no political constraints or bond vigilantes, would be to plan there will be QE3, QE4 and QE5. This will be the case for long-term gradual cuts in spending backloaded over time. not just the US but globally. The European Central Bank Bond vigilantes in the eurozone periphery do not (ECB) is being really stubborn, but when there is a double care that those countries are in a recession. The finan- dip in the eurozone, they will add liquidity too. Draining cial markets are demanding that these countries make a liquidity was a popular topic of discussion six months ago, fiscal adjustment now or else lose access to the capital but not currently. We need to have growth for a number markets. Every study, including the most recent one done of years to take up the slack in the labour and goods by the IMF, suggests that austerity does not crowd in markets. It takes several years where growth is above growth, it crowds it out. Fiscal consolidation is deflationary potential to reduce the 10 per cent unemployment rate and recessionary. If the bond vigilantes demand it, then closer to the natural rate of 5-6 per cent. Unemployment the way to counteract it is through massive monetary must drop to 4 per cent before you see wage inflation. stimulus. The ECB should then be doing massive amounts Growth must be sustained at 4 or 5 per cent for three or of QE like the US, but it is resisting it. The result is the four years before tightening monetary policy would be peripheral economies will see a double dip (actually, they applicable. never really got out of the first dip), so it is an “L” rather Exiting is easy to do. Reverse repos or higher interest than a “W”. The euro is going to 1.40 from 1.20, which is rates on excess reserves and other technical tools to mop going to destroy any chance of recovery at the periphery. up liquidity are well known and available. Volatility in financial markets is feasible if the Fed is not careful in its approach. It Q: To what degree do you think the deficit situation for is easier to avoid volatility when the economy is growing fast many states and municipalities in the US resembles enough. In 1994, the Fed moved the rate from 3 per cent to that of European sovereigns? the markit magazine – Winter 2010 Talking Business /9 “ In terms of size of the problem, individual states in the US are in as bad shape or worse than some of the peripherals in the eurozone.” A: In terms of size of the problem, individual states in the US EM within six to 12 months. Right now, a trigger to reverse are in as bad shape or worse than some of the peripherals the cash inflows is missing. in the eurozone. California and Illinois are good examples. Short $/long oil, short $/long gold, short $/long EM Some of the municipal spreads have widened but not yet currency, and short $/long EM equity or fixed income are far enough to cause the bond vigilantes to wake up fully. all basically the same trade. The correlations are close to The federal government has reduced some of the pain for one.