Mediocre Growth, High Risks, and The Long Road Ahead

By Olivier Blanchard

(Versions in Español, عربي)

For the past six months, the world economy has been on what is best described as a roller coaster.

Last autumn, a simmering European crisis became acute, threatening another Lehman-size event, and the end of the recovery.  Strong policy measures were taken, new governments came to power in Italy and Spain, the European Union adopted a tough fiscal pact, and the European central bank injected badly needed liquidity.   Things have quieted down since, but an uneasy calm remains.  At any moment, it seems, things could get bad again.

This shapes our forecasts.  Our baseline forecast, released by the IMF on April 17,  is for low growth in advanced countries, especially in Europe.  But downside risks are very much present.

Brakes hampering growth

This baseline is constructed on the assumption that another European flare-up will be avoided, but that uncertainty will linger on.   It recognizes that, even in this case, there are still strong brakes to growth in advanced countries:  Fiscal consolidation is needed and is proceeding, but is weighing on growth.  Bank deleveraging is also needed, but is leading, especially in Europe, to tight credit.  In many countries, in particular in the United States, some households are burdened with high debt, leading to lower consumption. Foreclosures are weighing on housing prices, and on housing investment.

These brakes to growth are reflected in our projections.  For advanced countries as a whole, we forecast growth of 1.4 percent in 2012, and 2.0 percent in 2013.   For the United States, the numbers are 2.1 percent and 2.4 percent.   For the euro area, the numbers are -0.3 percent and 0.9 percent.   The negative number for 2012 reflects negative growth in countries such as Italy and Spain; we forecast German and French growth to be positive, although quite low.

Turning to emerging and developing economies:   Our forecasts are for continued strong growth, although somewhat lower than in the past.  For many countries, the immediate challenges come mainly from outside, in the form of lower exports to advanced countries, volatility of commodity prices, and high volatility of capital flows.

The forecasts reflect our belief that most emerging and developing economies will be able to handle these challenges, by using the monetary and fiscal space they still have, and by using appropriate macro prudential measures to deal with the volatility of capital flows or high domestic credit growth.   Our forecasts for 2012 are for 8.2% for China, 6.9% for India, 3.0% for Brazil, roughly the same as in January, and slightly higher for Russia at 4.0%.    For sub-Saharan Africa, our forecast is for continuing strong growth, at 5.4%.

Putting things together, these forecasts imply a forecast for world growth of 3.5% for 2012, improving to 4.1% for 2013.   This is roughly 0.2% higher than our January forecast, but 0.5% lower than our forecast last September.

So, what are the risks?

Geopolitical tension affecting the oil market is surely a risk. The main risk remains, however, that of another acute crisis in Europe. The building of the “firewalls”, when it is completed, will represent major progress. By themselves, however, firewalls cannot solve the difficult fiscal, competitiveness, and growth issues that some of these countries face. Bad news on the macroeconomic or the political front still carries the risk of triggering the type of dynamics we saw last fall.

On the policy front:

Many of the policy debates center around how best to balance the adverse short-run effects of fiscal consolidation and bank deleveraging versus their favorable effects in the long run.

In the case of fiscal policy, the issue is complicated by the pressure from markets for immediate fiscal consolidation. It is further complicated by the fact that markets appear somewhat schizophrenic, asking for fiscal consolidation, but reacting adversely when consolidation leads to lower growth.

The right strategy remains the same as before: While some immediate adjustment is needed for credibility, the search should be for credible long-term commitments, by passing measures that decrease trend spending, and by putting in place fiscal rules that reduce deficits over time. Insufficient progress has been made along these lines, especially in the United States and in Japan.

In the case of bank deleveraging, the challenge is to make sure that deleveraging does not lead to a credit crunch, either at home, or abroad. Partial public recapitalization of banks should remain on the agenda. To the extent that it would increase credit and activity, it could easily pay for itself, more so than most other fiscal measures.

Turning to policies aimed at reducing risks, the focus is clearly on Europe.  The measures taken in response to the fall crisis represent important progress.  Further measures must however be taken to decrease the links between sovereigns and banks, from common deposit insurance, to common regulation and supervision.  Now that the fiscal pact has been introduced, Euro countries should also explore the scope for issuing common sovereign bonds.

Finally, taking one step back, perhaps the highest priority, but also the most difficult to achieve, is to durably increase growth and decrease unemployment in advanced economies, and especially in Europe. Low growth not only makes for a subdued baseline forecast, but also for a harder fiscal adjustment, and higher risks along the way. A search for structural and fiscal reforms that help in the long run, but do not depress demand in the short run should be very high on the policy agenda.

Such reforms probably hold the key to a successful and durable exit from the crisis.

7 Responses

  1. The biggest risk is that of having the same regulators keep on regulating using the same faulty regulatory paradigm that got us into this mess.

    It is always easier to get out of a hole if you understand how you got into it. I urge you all to read Chapter 3 “Safe Assets: Financial System Cornerstone?” of the IMF’ Global Financial Stability Report 2012 of the International Monetary Fund. You can find it here:

    http://www.imf.org/external/pubs/ft/gfsr/2012/01/index.htm

    From it you can easily understand the cause of the current crisis, if your hypothesis is that of an excessive regulatory risk-adverseness. But, if you insist, as most “experts” do, including those of the IMF, in using the hypothesis that the crisis was caused by the excessive risk-taking of the banks, you will not make anything useful or understandable out of the facts.

  2. […] This is an excellent blog from Olivier Blanchard, Chief Economist at the IMF. Why read citations in the news when you can read the real thing? Mediocre Growth, High Risks, and The Long Road Ahead « iMFdirect – The IMF Blog. […]

  3. The time when growth could be sold as an alternative to budget consolidation has passed. The realization that growth policy must be something more than the publication of new economic programs has gained acceptance for one simple reason: governments have no more money for deficit spending. What should take its place, however, is less clear. Whether the European Union (EU) will get beyond the Europa 2020 rhetoric is at the very least in doubt. It labors under the belief not only that growth is generated by decrees from Brussels, but also that it can be politicized by adjectives – such as “smart”, “sustainable”, and “inclusive”.

    Many of the current growth policy proposals share the idea with Europa 2020 that growth is generated above all with government money. These proposals are aimed not at short-term economic development, but at government “investments” in growth that will take effect over the long term, such as higher expenditures for research and development, government infrastructure projects, or expanded European project finance. It is also a fallacy to believe that growth on a larger scale can be financed with European money. Increasing growth potential is a difficult and lengthy exercise, and falls above all within the purview of member countries. What is needed can be described with the unattractive term “structural reforms”.

    Labor, goods, and services markets must become more open, privileges cut back, subsidies reduced.

  4. In its latest WEO, the IMF says that “real activity in Europe slowed by more than expected during the fourth quarter of 2011″. On June 20, 2011, I wrote the following comment: “In the latest projections, the IMF revised the euro area forecast upward although it is already quite obvious that economic growth will slow down”. On September 22, 2011, I wrote the following comment: “It is almost certain that economic growth in the euro area will become negative by the end of 2011″.

    So the new recession in Europe was not expected by the IMF but it was very much expected by me.

  5. […] Mediocre Growth, High Risks, and The Long Road Ahead – Olivier Blanchard […]

  6. It has been like that since the global financial crisis started; it seems that the crisis will be permanent and as with this “roller coaster” it has been that way since the financial markets started.

    What needs to be done by each nation and the U.S. is to tax their business elites and the wealthy elites so they pay their fair share of taxes and so money “real money not borrowed” can be spent on their economies to repair the damage of extreme capitalism!

  7. Increasing growth and employment in the euro area

    While fiscal adjustment measures and restructuring polices of debtor countries are necessary, there is a possibility that in the short or medium term, the recession and unemployment will not only decrease even more the payment capacity of debtor countries, but would also affect the degree of “trust” and the political and economic “stability” needed to implement the policy of adjustment and restructuring.

    If this is the case, let’s suggested the following “Plan B” to avoid the damaging effects not only in those countries, but to the others with whom they trade. So it is proposed to study that countries that are heavily indebted not only restructure their debts for longer periods, but also impose a deduction or write off to the debt owned by their creditors. This deduction should be lesser for those other creditors who decide to invest the payment they receive for their bonds and interest coupons in areas previously established by the public authorities. It is an offer of debt conversion into investment.

    The differential between the two different deductions must be sufficiently attractive to encourage investment. This differential could be reduced if it offers additional stimuli to investors such as the waiver of income tax for a long period of time.

    In the short term should be considered the acceleration of the investment process. This would be done by providing the bond creditors the possibility of turning bonds into immediate investments. The total that the country is willing to turn into investments would depend on the effect of these investments on inflation.

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