Things are somehow working,somehow we have avoided a collapse,but distress is still there

The US and the UK do not want to jeopardise growth prospects by withdrawing the stimulus too soon. The crisis is deeper there (in the USA). Germany and France are dependent more on the real economy. They value the real economy more. In global finance,intermediation is mostly to the extent of 70 per cent concentrated in the US and the UK,so they have special interests in cross-border finance. When we talk about stimulus fiscal and monetary we are trying to achieve normalcy in the financial sector and to stimulate demand to revive economies. But there are two sides to the real economy; supply and demand.

In some of the countries,they have created large capacities. The corporates have invested in large capacities and so there is scope for supply expansion,technically non-inflationary expansion. The unwinding of the excessively leveraged balance sheets and large-scale unemployment,all that meant there is a sudden drop in aggregate demand. There may be enough supply elasticity to take care of the stimulus in aggregate demand. From financing point of view,the rest of the world is prepared to finance the developed countries more willingly,at least for now,compared to others.

Now,you take the other side,where the aggregate demand is not so much a problem,but the demand for exportable goods is a problem and supply rigidities is also a problem. So,the type of situation that governs both the extent of stimulus and the withdrawal of stimulus will depend on the supply elasticity or rigidities and sources of deficiency in demand.

What are the other issues that need attention?

Second,there is a lot of internal debate within countries on the philosophy behind the structure of financial regulation. After an internal agreement is reached in respective countries,there needs to be an agreement among different countries,which is more complicated.

The third thing is the global financial architecture: right now the focus is on extending stimulus,remaining non-committal on fundamental changes in governance in multilateral institutions. In a flawed governance structure,you want to give more resources to the same institutions. In fact,the UN Commission,I mean Stiglitz Commission,has said there should be a separate window in which the administration of newly injected funds would be through a better governance arrangements.

Coming to the collapse of Lehman Brothers on September 15 last year… did you see it happening?

It was an incident,but essentially a reflection of some other serious problem. Market,regulatory,policy,moral failure or all put together. If Lehman didnt occur,some other thing would have happened. Lehman was a symptom of a disease. The problem is public policies globally did not prepare the world for a soft landing. Loose monetary policy,growing imbalances do you remember the whole debate in 2005-06? Suddenly we forgot that the world had to prepare for a soft-landing,in all the euphoria of growth. What I am saying is the collapse of Lehman Brothers is not a simple institutional or regulatory problem. It is far more fundamental.

Has there been adequate focus on regulation and revamping the architecture then?

There are two approaches. One approach is to handle the financial crisis first and restore the confidence. After the financial crisis is over,when normalcy is restored,at that point of time focus could be on macro and structural problems. This is one theory that insists that we should not dilute the focus on the crisis by bringing in other factors that are also contentious,difficult. So,dont complicate matters.

The other point of view is that the financial markets are so powerful,what they are seeking is only to get the financial markets in order so that privatised profits can be moved to where they were,losses get socialised,so it will be back to the old world order. So there is a fear that the reforms that ought to be done to have a more stable global economy may be abandoned or get postponed.

You have to see how the agenda is driven. You must recognise that all actions are by far national and each nation is taking policy action in one direction to manage the crisis situation. The same type of commitment and convergence may not be there once the crisis is over.

The UNCTAD report on trade and development and the Stiglitz Commission report give a fairly objective and professional view without having the compulsions to agree for a consensus on immediate implementation. Unfortunately,they are not placed in the centre of debate or action.

It is one year post-crisis now. Has normalcy been restored?

The question is,what is normalcy? There was a virtual breakdown of credit markets and money markets. That has been addressed. There was huge volatility in exchange rates. Concerted action was taken. Few developing countries are having acute crisis,and they are being helped with external finance but they still have some problems. As far as financial institutions are concerned,they were excessively leveraged,undercapitalised and had assets of suspect quality. This problem of asset quality has been taken over by central banks. Institutions were recapitalised by public sector. In other words,institutions have been brought back to health,but it is not yet the normal way the institutions are supposed to exist in terms of their ownership and capital structure. So,it is one thing to say that institutions are functioning normally and another that full normalcy has been restored. The institutions are working normally,but they are not the way they should be in normal circumstances. For them to be described as normal,we have to withdraw the special support.

Then the regulatory regime: there were significant special dispensation,accounting standards,special tax concessions in some countries. In other words,stimulus,by definition,is supposed to be temporary. Today,the situation is such that things are somehow functioning. Somehow functioning markets,somehow functioning institutions,somehow we have avoided a collapse. But economic distress is still there. The other question is the type of stimulus measures extended so far…whether they are exacerbating the future resolution of the imbalance.

Many have likened the present crisis to the Great Depression. Do you think,its as big or such a parallel is unwarranted?

In terms of fundamental problems in the global economy that have cropped up now,there is some reason to believe they are comparable. In terms of the consequences,one view is that the Great Depression could have been avoided by appropriate action. At the same time,it is difficult to hold that fundamental changes were required. Even the new theory that developed,the Keynesian theory,is a product of the Great Depression. Multilateral institutions are a product of depression. Some say even the World War II was a product of depression. So it changed the world. The act of the Great Depression saw a global shift in power to the Americas.

So,the issue really is if they are comparable,will we see similar shifts taking place? Or not? We dont know. So the comparison is not simply in terms of possible monetary or financial scale. This will be a limited view. It is the real economy,real rebalancing of power that is more important. In any case,we are in different worlds relative to the Great Depression.