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U.S. policy stance holds the key

The economic crisis in the United States, now considered graver than was thought some time ago, has prompted some strong policy measures that are unprecedented in scope as well as in timing. In a span of just eight days, the U.S. Federal Reserve has brought down federal funds rate from 4.25 per cent to 3 per cent. The President and the Congress have agreed on a fiscal stimulus package, costing $150 billion. Whether all the expected outcomes — cheaper credit, more money with the consumers, and help for the unemployed — will be able to stimulate the flagging consumer demand and thereby save the economy from sliding into recession remains to be seen. After all, there are other, interrelated threats that have aggravated the crisis. The sub-prime and the housing market crises, which triggered the downturn, show no signs of ending. Despite enormous injections of liquidity, there is a credit squeeze and, as defaults mount alarmingly forcing the banks to make enormous provisions, the economic outlook gets worse. According to reports, the economy has replaced the Iraq war as the major area of concern among American voters.

Given the pre-eminent role of the U.S.’s economy in global growth, it is inevitable that world economic growth will slow down this year. According to the World Bank, global economic growth in 2008 is expected to be 3.3 per cent, down from 3.6 per cent last year. Developing countries would cushion, but not make up for the slowdown in the developed countries. The proponents of what is called the “decoupling theory” argued that, with the rise of India and China and the growth of bilateral trade between Europe and China, the global economy can be kept insulated from the economic travails of the U.S. The recent meltdown in the global stock markets, acting on cues from the U.S., exposed the limitations of that theory. Financial markets the world over are strongly interlinked and the U.S. is not only the largest exporter and importer of goods and services but also of capital. In India, portfolio flows into the stock markets might come down. A weakening dollar has pushed up the rupee to punishing levels from the exporters’ point of view. The health of the Indian economy, as indeed the health of the world economy, would seem to hinge on how effective the policy measures in the U.S. will be in staving off a recession.

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