Stepping out of the shadow of the crisis:
three transitions for the world economy
* Seven years on, the Great Financial Crisis still casts this long shadow on the world economy. The good news is that the global economy is healing and global growth has picked up during the past year. Reforms have taken hold, if unevenly. The recovery in the advanced economies has broadened. The euro area has eventually emerged from recession, while the slowdown in emerging market economies (EMEs) seems to have abated. The consensus expectation is for global growth to gradually return to pre-crisis
* The less good news is that challenges continue to be serious and new risks are emerging. By historical standards, the upswing has disappointed. But this should not be surprising. Consumers, firms and banks in crisis-hit economies are still repairing their balance sheets and grappling with an overburden of debt. Private sector deleveraging is most advanced in the United States; in other countries, including large tracts of the euro area, it is still very much work in progress. During the boom, resources were misallocated on a huge scale, and it will take time to move them to new and more productive uses. Meanwhile, a number of EMEs have moved into the late stage of their own financial booms. While these booms have helped to extricate the global economy from the Great Recession, they are now confronting the EMEs with a range of economic risks. And these risks cannot be altogether offset by the additional room for policy manoeuvre that the EMEs have won for themselves over the last few years.
* A negative aspect of this debt-driven growth pattern is the relative weakness in investment in advanced economies. True, at the global level, total fixed investment as a share of GDP has continued to rise thanks to rapid growth in the EMEs. It is also true that, in some countries, a correction of overinvestment in housing and construction was overdue. But other investment patterns do not bode well for future growth. In many advanced economies, for example, companies are holding back on investment in plant and equipment. Infrastructure investment is also languishing, particularly in a number of EMEs but also in some advanced economies.
* But what about the risk of secular stagnation? Debt is not the only headwind to growth; there are also structural deficiencies. In the advanced economies, productivity growth has been on the decline since long before the crisis, a trend previously masked by the financial boom (Graph 2). And the drag from ageing populations is well known. In addition, there are country-specific factors, including a structural fall in participation rates, or a sectoral misallocation of credit and resources. All these are structural impediments to demand and growth.
* Monetary accommodation is testing its limits. Monetary policy loses a great deal of its effectiveness in the recovery phase of a balance sheet recession when households, corporates and banks are all struggling to repair their balance sheets, thus entrenching the weakness in aggregate demand. There is a threat to financial stability too, as ultra-low interest rates promote debt accumulation and risk-taking.
* The road towards normalisation is bound to be bumpy and full of challenges. Let me mention two. The first is how to make financial markets less dependent on monetary policy. The second challenge is to cope with the international spillovers of monetary policy.
* This leads me to the question of persistently below-target inflation and what it implies for monetary normalisation. True, low-inflation, low-growth environments are not helpful from the perspective of those with heavy borrowings. But let me make two qualifications here. First, central bank inflation projections and well anchored long-term inflation expectations seem to suggest that the risk of persistent and self-reinforcing disinflationary pressure is low. Moreover, there are good reasons to believe that downward pressure on inflation reflects positive supply side effects in the global economy, at least in part. Greater competition in markets for goods and, increasingly, also for services reduces the scope for raising prices, and it may even force them downwards. This year's Annual Report documents the important role of such global factors for domestic inflation. All this suggests there are significant uncertainties in projecting inflation. And there is a need for more research about the new dynamics of inflation, the growing role of international factors and the shrinking sensitivity to domestic output gaps.
* Second, the low rates of inflation worldwide are another sign that, coming out of a balance sheet recession, monetary policy typically has much less traction in stimulating demand than it does during a normal recovery. One piece of evidence is the stark disconnect between very accommodative financial conditions on the one hand and sluggish corporate investment on the other. It is therefore important to take a critical look at what monetary policy can realistically accomplish right now. After years of easy money, we need to pay more attention to the risks of normalising too late.
* But pockets of weakness and uncertainty persist, especially in Europe. Despite an improvement in aggregate profitability, many institutions are still struggling with high levels of government and household debt. Standalone ratings remain weak. Investors continue to ask questions about asset quality. Elsewhere, in some economies that largely escaped the effects of the crisis, financial booms have created new vulnerabilities.
* It is time that we stepped out of the shadow of the crisis. Stronger growth provides an opportunity to push through structural reforms and set balance sheets on a firmer footing. We can hardly expect such efforts to be popular. But they may pay off even in the short run if they help to restore confidence. The time is right because delaying any of the three transitions poses risks. A first risk is financial dominance: delaying policy action for fear of market volatility and financial fragility. A second threat is fiscal dominance: that is, pressure to pursue a policy of easy money so as to sustain high debt levels. And a third threat is expectations dominance: namely, unrealistic expectations of what central banks can do. Failure to ensure the success of any of these transitions would exact a high price in terms of growing risks to financial and macroeconomic stability.
José Luis Martínez Campuzano
Estratega de Citi en España
José Luis Martínez Campuzano
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