Coordinated Stimulus at the G-20: Why and How

Getting agreement on general language in support of all countries undertaking counter-cyclical macroeconomic stimulus measures at the upcoming G20 Summit will be easy, especially now that China and the United States have signaled plans for their own major fiscal packages. Getting a commitment to specific common policy actions will be difficult, as past summits have demonstrated.

Yet such a joint commitment is essential. Having some countries free ride on others' fiscal and monetary stimulus efforts will reduce the effectiveness of the package as a whole. In addition, divergent national policies, even if they are all in the same direction of ease, will add to the world's financial volatility. Lack of coordination on either front could lead to rapid shifts in exchange rates (encouraging beggar-thy-neighbor attempts), runs on currencies (such as the dollar), and a destabilization of inflation expectations.

I would suggest that the participating governments in the November 14-15 summit commit to the following program for coordinated stimulus:

1. Make a common public commitment by their central banks not to raise interest rates at least until the two-year inflation forecast for a weighted majority of participant countries is increasing. This commitment would:

a) Build on Japan's experience that commitment affecting future inflation expectations improves credit conditions and behavior today;

b) Give central banks' additional ammunition as they approach a zero level of nominal interest rates.

c) The key is that the commitment not to raise interest rates must be based on waiting until the inflation forecast is increasing across a range of participating countries –not based on any specific inflation level itself, which will differ across countries.

2. Issue all new net government debt by participating countries to fund stimulus in a fixed set of currencies (e.g., 35% of each issued in USD, 25% in euros, 15% each in sterling and yen, and 10% in yuan to start) and of short (less than 5 year) maturity. This action would:

a) Make it easier to credibly claim that all countries are acting together, and provide an incentive for those countries that might be reluctant to issue enough debt-financed stimulus (e.g., Germany) to go along with others who will already be issuing in their currency;

b) Limit the impact of debt issuance on exchange rates, and make it easier for emerging market members to get funding;

c) Constrain the duration of fiscal expansions, while taking advantage of low short-term rates.

3. Undertake joint global projects regarding global warming and/or Millennium Development Goals (clean water, malaria prevention, solar panels/wind farms, etc.). This would:

a) Attract a minimum commitment from all participating countries;

b) Provide great political cover to increase development aid during tight times;

c) Have higher global potential output benefits than the rich countries' domestic infrastructure.

4. Commit jointly to lowering consumption taxes now, along with a pledge to raise them in the future, thereby inducing shifts in consumption from tomorrow to today, with a three year horizon for the coming increase. More specific measures might include:

a) A future minimum carbon tax for each country, which would not only promote consumption today but also encourage new investment in greener equipment ahead of the increase;

b) A tax holiday on excise taxes for fuel-efficient autos and environmentally efficient durable goods and home improvements;

c) A joint tax holiday on the title and other transfer fees in real estate markets;

5. Have the OECD (the organization of leading market economies) and the International Monetary Fund (IMF) report accurately on net public debt levels (not gross), cyclically- adjusted budget levels, and temporary asset acquisitions versus government expenditures that result from stimulus and financial reform efforts. Building on this step:

a) Participating governments should speak and issue reports using only the accurate (net, cyclically adjusted, etc.) figures in all G-20 government statements to give a consistent but fair benchmark;

b) All governments should thereby reassure markets and savers that fiscal policy is being controlled, recalling that misunderstanding about such matters as net vs. gross debt, and cyclically vs. structural deficits, poisoned both the Japan stimulus discussion in the 1990s and monitoring of the European Union's Stability and Growth Pact in the 2000's.