The World’s Three-Speed Economic Recovery
The main theme of our latest outlook is one that you have now heard for a few days: we have moved from a two-speed recovery to a three-speed recovery.
Emerging market and developing economies are still going strong, but in advanced economies, there appears to be a growing bifurcation between the United States on the one hand, and the Euro area on the other.
This is reflected in our forecasts. Growth in emerging market and developing economies is forecast to reach 5.3% in 2013, and 5.7% in 2014. Growth in the United States is forecast to be 1.9% in 2013, and 3.0% in 2014. In contrast, growth in the Euro area is forecast to be -0.3% in 2013, and only 1.1% in 2014.
The growth figure for the United States for 2013 may not seem that high, and it is indeed insufficient to make a large dent in the still high unemployment rate. But it comes in the face of a very strong, I would even say overly strong, fiscal consolidation of about 1.8% of GDP. Underlying private demand is actually strong, spurred in part by the anticipation of low policy rates under the Fed’s “forward guidance’’, improving banking conditions, and pent up demand for housing and for durables.
The forecast for negative growth in the euro area reflects not only weaknesses in periphery countries, but also some weaknesses in the core.
Germany’s growth is strengthening, although it is still forecast to be only 0.6% in 2013. France’s growth is forecast to be slightly negative in 2013, reflecting a combination of fiscal consolidation, poor export performance, and low confidence. Low growth in the euro core is bad news on its own, and bad news for the euro area periphery countries.
We expect most euro area periphery countries, notably Italy and Spain, to have substantial contractions in 2013. The process of internal devaluation is slowly and painfully taking place, and most of these countries are slowly becoming more competitive. However, external demand is just not strong enough to compensate for weak internal demand. Adverse feedback loops between weak banks, weak sovereigns, low activity, and, increasingly, low confidence, are still reinforcing each other.
Japan is forging a path of its own; it may have been more accurate to talk about a three and a half rather than a three speed recovery. After many years of deflation, and little or no growth, the new government has announced a new policy, based on aggressive quantitative easing, a positive inflation target, fiscal stimulus, and structural reforms. This policy will boost growth in the short run, and this is reflected in our forecast of 1.4% growth for 2013. Given the very high level of public debt however, embarking on a fiscal stimulus in the absence of a medium run fiscal consolidation plan is risky; it increases the probability that investors require a risk premium, and that this leads in turn to debt unsustainability.
In view of this mixed picture in advanced economies, emerging market countries are, in general, doing well. We forecast China to grow at 8.0% in 2013, although this forecast was made before yesterday’s numbers were announced, and we are still analyzing these numbers, India at 5.7%, and Brazil at 3.0%—in all three cases, higher growth rates than in 2012.
In the past, the conditions that prevail today, from high commodity prices, to low interest rates, to large capital inflows, often would have led to credit booms and overheating. So far, policymakers have generally succeeded in keeping aggregate demand in line with potential. At the same time, potential growth itself has declined in a number of emerging economies, and we shall not see again some of the high growth rates of the past.
Turning to policies:
In the United States, the focus should be on defining the right path of fiscal consolidation—reducing government debt and deficits. While the sequester has decreased worries about debt sustainability, it is the wrong way to proceed. There should be both less and better fiscal consolidation now, and a commitment to more fiscal consolidation in the future.
In the euro area, institutional progress has been made over the past year, in particular on a road map for a banking union. The Outright Monetary Transaction program offered by the European Central Bank, as yet untested, has reduced tail risks. But this is not enough.
The interest rates facing borrowers in periphery countries are still too high to secure the recovery, and there is a need for further and urgent measures to strengthen banks, without weakening the sovereigns. The weakness of private demand also suggests that countries that have scope to do so should allow automatic stabilizers to operate, and in some countries with fiscal space, should go even beyond this and reconsider the speed of fiscal adjustment.
Emerging market countries face different challenges, in particular the handling of capital flows. Fundamentally attractive prospects in emerging market countries, together with low interest rates in advanced economies, are likely to lead to continuing net capital inflows and exchange rate pressure in many emerging market countries. This is a fundamentally desirable process, and part of the global rebalancing which must take place if the world economy is to return to health.
At the same time, as we have seen, capital flows can be volatile, making economic management more difficult. The challenge for recipient countries is to accommodate the underlying trends, while reducing the volatility of the flows when they threaten economic or financial stability.
In short, recent good news about the United States has come with renewed worries about the euro area. Given the strong interconnections between countries, an uneven recovery is also a dangerous one. In some ways, the world economy is as weak as its weakest link. While some tail risks have decreased, it is not time for policy makers to relax.