State of Play: The Global Economy on Two Tracks
First of all, economic performance is becoming bifurcated.
Advanced and emerging economies are moving in the same direction-that is,
growth everywhere is slowing, decisively ending any hopes of a growth
decoupling but they are facing two different sets of problems. Nearing the end
of the year's third quarter, most advanced economies are either virtually
stagnant or on the verge of recession, while underlying inflation risks are
becoming increasingly well contained.
The growth slowdown that originated in the United
States has spread, as evidenced by declines in activity in the second quarter
in both the euro area and Japan. Advanced economies, in general, face a spell of growth well
below potential, as they grapple with ongoing strains from the financial crisis
that began a year ago, as well as the lingering effects of high oil prices and
weaker external demand.
Henceforth, Inflation is still a key problem for some
emerging economies and tighter policies are still required in some cases so as
to ensure that hard-won gains in monetary policy credibility are not eroded.
But for many other emerging economies, downside risks to growth are increasing,
while risks to inflation appear more subdued. As the balance of risks shifts,
so should policymakers' responses.
The Global Outlook: A Gradual Recovery
There are several factors that provide a degree of
reassurance that a severe downturn can be avoided. They are:
- First, oil prices have come down sharply in recent
weeks. This should reverse a significant portion of the adverse terms-of-trade
effects arising from the more than 60% increase in oil prices during 2008
and the erosion in purchasing power and real wages being felt by most
advanced economies.
(In the United States, if oil prices remain at current levels, the implied
boost to real disposable income will rival the value of the income tax
rebates. Indeed the projections expected a modest rebound in consumption
in both the United States and euro area over the course of 2009.)
- Second, it is plausible to anticipate that the U.S. housing market will find a bottom in 2009. Already, the inventory overhang is
diminishing, while affordability measures are returning to levels that
appear much more consistent with past experience.
- Third, while financial conditions have tightened in
both the United States and in Europe, it does not mean that an economic
recovery is thereby excluded. In the United States, for example, corporate
finances in general remain relatively healthy. Productivity gains have
helped to sustain profits. Time-limited investment tax credits will
encourage corporate capital expenditures in the coming months. Moreover,
recent IMF analysis suggests that a slowdown in credit intermediation does
not necessarily impede economic recovery.
- Finally, relatively robust emerging market growth, led
by strong domestic demand in several of these economies, has helped boost U.S. exports.
Hence, the challenges facing the global economy and
financial system are clear, and downside risks to the outlook have increased
notably. The overarching risk revolves around the feedback loop between
continuing strains in financial markets and slowing economic activity. Despite aggressive policy actions aimed
at alleviating liquidity strains and preventing systemic events, markets remain
under severe stress. There is a clear risk that financial conditions could
deteriorate further and more aggressive attempts by financial institutions to
deleverage balance sheets could imply severe problems of credit availability. There also is a clear risk that emerging market
economies that have so far been relatively insulated from the financial turmoil
could be subject to large reversals of capital flows, with serious implications
for economic activity.
To conclude, the implication is that a more systematic
approach may be required to deal with such basic issues as the disposition of
distressed assets, the degree of protection offered to depositors, and the
scale and scope of liquidity support that is offered to institutions and
markets.
"The fact of globalized financial markets means
that policy interventions need to be globally coherent and consistent in order
to be effective. Although, the global economy will continue to be resilient in
the face of significant headwinds, this does not imply that the policy
challenges and tradeoffs are not daunting it will be navigating successfully
through the turbulent waters ahead".
Source: AEPC Weekly
