The Current Economic Sweet Spot Is Not the “New Normal”
IMF Blog, January 22, 2018
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- Authors: Maurice Obstfeld
- Published: January 22, 2018
Overview and headline forecast
- The new World Economic Outlook Update revises the forecast for the world economy’s growth in both 2018 and 2019 to 3.9 percent.
- For both years, that is 0.2 percentage points higher than last October’s forecast, and 0.2 percentage points higher than our current estimate of last year’s global growth.
- The present economic momentum reflects a confluence of factors that is unlikely to last for long; without prompt action the next downturn will come sooner and be harder to fight.
Near-term prospects and drivers
- Primary sources of GDP acceleration so far: Europe and Asia, with improved performance also in the United States, Canada, and some large emerging markets (notably Brazil and Russia, both of which shrank in 2016, and Turkey).
- The recent U.S. tax legislation will contribute noticeably to U.S. growth over the next few years, largely because of the temporary exceptional investment incentives that it offers.
- This short-term growth boost will have positive, albeit short-lived, output spillovers for U.S. trade partners.
- It will also likely widen the U.S. current account deficit, strengthen the dollar, and affect international investment flows.
- Trade is growing faster than global income, driven in part by higher global investment.
- Commodity prices have moved up, benefiting commodity-exporting countries.
- Inflation pressures remain contained even as economies return to full employment; nominal wage growth is subdued.
- Financial conditions are quite easy: booming equity markets, low long-term government borrowing costs, compressed corporate spreads, and attractive borrowing terms for emerging market and developing economies.
Explaining the upturn
- The upturn began to take hold in mid-2016 and owes much to accommodative macroeconomic policies that supported market sentiment and hastened natural healing processes.
- Monetary policy:
- Remains accommodative in the largest countries, underpinning easy global financial conditions.
- The United States Federal Reserve continues to raise interest rates gradually but has been cautious, postponing previously expected rate increases after early-2016 turbulence.
- The European Central Bank has started to taper large-scale asset purchases but has signaled that interest-rate increases are a more distant prospect.
- Fiscal policy:
- In advanced economies, fiscal policy has shifted from contractionary to roughly neutral over the past few years.
- China has provided considerable fiscal support since its growth slowed at mid-decade, with important positive spillovers to trade partners.
- In the U.S., fiscal policy is about to take a markedly expansionary turn, with complex effects on the world economy.
Why this is not a “new normal” — key medium-term risks
- Advanced economies are leading the upswing, but once their output gaps close they will return to longer-term growth rates expected to be well below pre-crisis rates.
- Projected advanced-economy growth: 2.3 percent in 2018.
- Assessment of the group’s longer-term potential growth: only about two-thirds as high.
- Causes: demographic change and lower productivity growth.
- China and the United States—the two biggest national economies driving current and near-term future growth—are headed for slower growth.
- China will cut back fiscal stimulus and rein in credit growth as part of rebalancing, implying lower future growth.
- U.S. tax cuts are temporary in effects (notably for investment); some of the near-term growth will be paid back later as incentives expire and increasing federal debt takes a toll.
- Easy financial conditions and fiscal support have left a legacy of debt (government, and in some cases corporate and household) in advanced and emerging economies.
- A sudden rise in inflation and interest rates would tighten financial conditions globally and prompt markets to re-evaluate debt sustainability in some cases.
- Elevated equity prices are vulnerable, raising the risk of disruptive price adjustments.
- Regional and distributional concerns:
- Less favorable developments in the Middle East and Sub-Saharan Africa; Sub-Saharan Africa weighed down by weakness in its larger economies.
- Low growth in parts of Africa driven in part by adverse weather events and sometimes civil strife, sparking significant outward migrations.
- Aggregate growth in Latin America will be weighed down in the year by continuing economic collapse in Venezuela.
- Voters in many advanced economies have soured on political establishments due to tepid real wage gains, reduced labor shares, and rising job polarization; this raises the risk of a turn to more nationalistic or authoritarian governance models.
- Levels of inequality are high in emerging market and low-income economies and can spark future disruptions unless growth is made more inclusive.
Policy implications and recommendations
- Over-arching risk: complacency among policymakers.
- Immediate policy priorities:
- Build policy buffers and reinforce defenses against financial instability.
- Invest in structural reforms, productive infrastructure, and people to raise long-term economic efficiency and output.
- Ensure availability of policy tools to counter the next downturn, given that public debts are much higher than a decade ago.
- Multilateral priorities during the upswing:
- Counter global financial stability threats, including cyber-threats.
- Strengthen the multilateral trading system.
- Cooperate on international tax policy, including the fight against money laundering.
- Promote sustainable development in low-income countries.
- Fight irreversible environmental damage, notably from climate change.
Maurice Obstfeld — January 22, 2018
