Global Growth Hits a Soft Patch

By Olivier Blanchard

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Today we’re in Sao Paulo, Brazil, to release our update to the IMF’s World Economic Outlook.

Despite a mild slowdown, the global economic recovery continues but the road to health will be a long one.  Downside risks, both old and new, are increasing.

Our world forecast is 4.3% growth for 2011, and 4.5% for 2012, so down by 0.1% for 2011, and unchanged for 2012, relative to April.  This figure hides very different performances for advanced economies on the one hand, and for emerging and developing economies on the other. 

We forecast advanced economies to grow at 2.2% for 2011, and 2.6% for 2012, down by 0.2% in 2011, and unchanged for 2012.  And our forecast for emerging and developing economies is 6.6% growth for 2011 and 6.4% for 2012, up by 01.% for 2011, and down by 0.1% for 2012.

Two advanced countries have seen larger downward revisions.  The first is Japan where we now predict negative growth for 2011.   Disruptions from the earthquake have been stronger than we anticipated, and account for most of the decline.  We expect these problems to go away, and the economy to rebound more strongly in 2012.

The second is the United States, where we have revised our forecasts down by 0.3% in 2011, and 0.2% in 2012.    While it is too early to tell, we see this as a bump in the road rather than something more worrisome.  Special factors, in particular the effect of oil prices on disposable income, appear to have played an important role.   But, assuming oil prices stay broadly stable, in line with financial markets’ expectations, spending by consumers and firms should remain steady in what is, admittedly, a weak recovery.

Brakes to growth are still very much present in advanced countries.    Fiscal consolidation is needed, but weighs on demand in most countries.  Continuing weaknesses in the financial system, in particular undercapitalized banks, are slowing down lending.    By contrast, many emerging market countries face the risk of overheating.   While they are tightening policy, many of them will need to do more.

Risks to the recovery are clear, and more to the downside than 3 months ago.    I shall focus on three such risks. 

  • The first and obvious one comes from Europe.   In the best of cases, improving competitiveness and returning to fiscal health in some of these countries will be a long and painful process.  It will require strong policies, namely fiscal consolidation, structural reforms, and policies which protect the most vulnerable.  It will also require help and outside financing, official and private.  These countries cannot do it alone.

The stakes are very high:  failure to commit to and implement policies, or failure to deliver on financing, hold the risk of triggering disorderly financial and sovereign defaults.   Contagion through various channels to the rest of Europe then holds the risk of derailing the European recovery and perhaps even the world recovery.

  • The second risk is on the fiscal side, and affects a large number of advanced countries.  Many countries, including the United States, are yet to put in place a convincing medium term fiscal consolidation plan.  Such a lack of adjustment leads markets to worry.  Worries lead to higher risk premia, increasing the cost of borrowing not only for the sovereign but also for private borrowers.   Or they force countries into precipitated fiscal adjustments, leading also to sharp decreases in demand.  In both cases, growth may be derailed.
  • The third risk concerns emerging market economies.   The difference between a strong and an overheating economy is often difficult to tell in real time, but there are reasons to think that a number of emerging countries may be close to crossing the line.  Inflation is increasing beyond what can be explained by commodity and food prices.  Credit growth rates and some asset prices are starting to look high relative to historical standards.

Some economies, with both strong domestic demand and strong capital inflows, face difficult policy choices.  Some countries, in particular in Asia, should allow for further appreciation of their currency and a reduction of their current account surplus.  Others, in particular in Latin America, have already allowed for a substantial appreciation, and their adjustment must take place at other margins.  All must use the right combination of instruments at their disposal, fiscal, monetary, and macro prudential, to slow their economies in time and avoid costly boom-bust cycles.

So the global recovery continues.  But the road to health is still a long one.   And it is surely no time to relax.

4 Responses

  1. The IMF did not predict the crisis, and it did not predict the recovery (in October 2009, it forecasted just 0.3 real GDP growth in the Euro Area in 2010). In the latest projections, it revised the Euro Area forecast upward although it is already quite obvious that economic growth will slow down. Wrong predictions reflect wrong macroeconomic models used at the IMF.

  2. Olivier Blanchard vs Bill Gross

    Dr. Olivier Blanchard pictured the financial problems in the U.S. as “a bump in the road rather than something more worrisome,” and expects some “convincing medium term fiscal consolidation plan”. Meanwhile PIMCO’s Bill Gross, responsible for the largest bond fund in the world with more than $1.2 trillion in assets, advised investors to flee the country: “You must get out of the United States … 10, 20, 30 years from now” (Opening Keynote Speach, 2011 Morningstar Investment Conference, Chicago, June 8, 2011),

    01:04 – 01:09

    At least one of them was joking.

    D. Chakalov

  3. The European Association of European Public Banks (EAPB)
    convened its third Chief Economist Meeting in Sweden and discussed
    “Can the Euro Zone learn any lessons from the rapid Swedish recovery after banking crisis?” Chief economists and experts of EAPB Member Banks and partners from various European countries took part in the meeting and gave their opinion on the current economic situation. Further contributions by Mikael Sandström, State Secretary to the Swedish Prime Minister, Fredrik Reinfeldt and by Claes Berg, Advisor to the Governor at Sveriges Riksbank were on the agenda. As a major focus point the issue was raised whether the Euro Zone can learn any lessons from the rapid Swedish recovery after the banking crisis and if so, which ones. It was concluded there are six key areas in which the euro zone could benefit from the Swedish recovery:
    1) The Government has to be quick to act
    2) Liquidity needs to be kept into the banks
    3) Public finances need to be put in order
    4) Work shall be made to pay again such as reforms to tax credits and benefits
    5) Long term growth plans should be put in place through pensions reforms and competition
    6) Weaker groups’ employment possibilities need to be supported with education and vocational training
    The group discussed the importance of political consensus if the six above-mentioned pieces of advice were to be implemented.

    Two more areas were tackled. On the one hand the global financial crisis and the Great Recession including factors which influence a sustainable financial environment was discussed. On the other hand there was the issue of demographic challenges to the EU Member States with regard to adequate retirement income and future health care expenditures.

    Lena Bäcker Chief Economist at Kommuninvest in Sweden, Moderator at the Chief Economist Network and Senior Advisor at Swedish Government expert bodies.

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