Another Year of Panic?

PARIS: Brazil's currency devaluation earlier this year, and its difficulties since in stabilizing the real as well as its stock market, have demonstrated the importance, if any new proof was needed, of financial markets and their volatile mood swings. There can no longer be any doubt that investor panic can provoke economic meltdown, as it did in Asia and Russia last year, still threatens to do in Brazil and across Latin America, and may yet stage an encore in Asia over worries about a devaluation in China and the spiral of competitive devaluations that could follow.

Now in its eighth year, the almost obscene economic growth in the United States could be used to illustrate the inverse proposition. On at least two occasions in 1998, bad news could have set off a crash in American stock prices and an economic recession. After all, the majority of observers (analysts, too) had concluded that Wall Street was overvalued, even before the onset of the Asian crisis. Stock prices did, of course, decrease as a result of the Asian panic and its financial ramifications, but America's stock markets have since then recouped all of their initial losses and even moved on to new record highs.

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The impeachment trial in the US Senate of President Clinton and the political crisis that could have amplified both political and economic uncertainty, leading to another sharp fall in prices on Wall Street, also had absolutely no effect on Americans and how they spend and save their money. Investors and consumers did not lose their optimism. Nothing seems able to shake them. Could the American public's faith in Alan Greenspan, chairman of the Federal Reserve Board, America's central bank, be a satisfactory explanation? He's done a solid job, but I doubt that this can be the only cause of American buoyancy.

So what factors get economies going and keep them humming? In Europe, the advent of the Euro has certainly not invigorated economic growth, and does not look likely to do so anytime soon. The best news of the year is that, at long last, the Continent's consumers seem to be emerging from their long depression. In contrast to the United States, however, the boost in consumer demand has not become an engine of growth. Why not? Probably because the macroeconomic policies of Europe's governments were, and remain, overly cautious and have not dared provide the necessary kick-start.

Having satisfied the Maastricht criteria, fiscal policies have been geared to putting on brakes. Across "euroland" monetary policy was focused on the harmonization of interest rates, not on their level. So there is little reason to be terribly optimistic for the near future, neither for growth nor job creation.

Still, there is an upside here. Europe's relatively newfound fiscal discipline probably was a blessing in maintaining market confidence, and thus in immunizing the Continent, during the Asian, Russian, and Brazilian financial panics. In Japan, sad to say, that sort of fiscal austerity remains something of a curse.

Sad to say, Japan continues to teach us that some of history's most painful episodes do repeat themselves. A series of vicious cycles that one had hoped had vanished with the end of the Great Depression have shown themselves to be relevant today. Deflation increased real interest rates and curbed economic activity, thereby setting off another round of deflation, and so on. With interest rates reaching almost zero, this liquidity trap has paralyzed Japan's monetary policy.

Keynesian remedies (now being tardily applied) and an expansionary fiscal policy have not been able to jump-start the Japanese economy and bring about a return of optimism. Is it because the Japanese government delayed action for too long before accepting budget deficits? No one really knows.

Is it possible to discern a common thread to all of these developments? I see two of them. The first one is the importance of what Keynes called "animal spirits." In all cases, they have been at the center of today's economic successes and failures.

The second one is that it is quite difficult to tame those animal spirits. Why did international investors panic in South East Asia? Why has, say, Poland been relatively immune to the panic caused by Russia while the rest of Eastern Europe caught cold? Why do American consumers seem to be immunized against pessimism? Is there a macroeconomic policy that could boost the still shaky optimism of consumers? How can Japan restore optimism and jump-start its economic engine with no macroeconomic tools left to use? These are the questions on which governments must now focus. On the answers will depend the health of the global economy.