Crisis Mismanagement in the US and Europe

There are two major failings in policy interventions in the crisis in the US and Europe: the reluctance to remove the debt overhang through timely, orderly and comprehensive restructuring and the shift to fiscal austerity after an initial reflation. These have resulted in excessive reliance on monetary means with central banks entering uncharted policy waters, including zero-bound interest rates and the acquisition of long-term public and private bonds. This ultra-easy monetary policy has not been very effective in reducing the debt overhang and stimulating spending. It has, however, generated financial fragility, at home and abroad, particularly in the case of the US as the issuer of the key reserve currency, and exit is full of pitfalls. Although ultra-easy money is still with us, the markets have begun pricing-in the normalization of monetary policy in the US and this is the main reason for the turbulence in emerging economies. Policy response to an intensification of the stress in the South needs to depart from past practices and should include measures to involve the private creditors in crisis resolution and provision of market support and liquidity by central banks in major advanced economies.