Global economy warrants concern, not panic
Over the past few weeks the financial markets have calmed down somewhat from their hysterical turmoil at the beginning of the year. With the frenzy having dissipated, the debate has returned to the rather more fundamental question of whether the underlying global economic recovery is in trouble, and what governments and central banks can do about it.
This week saw two contributions on that subject, somewhat at a tangent to each other. The first was the International Monetary Fund, increasing the volume of its persistently pessimistic tone in arguing that “protracted low global demand”, the reversal of capital flows to emerging markets and deep uncertainties over China were reducing world economic growth expectations.
The second, a self-styled “reality check”, came in the form of an unusual intervention by economists at the Peterson Institute for International Economics, including the IMF’s former chief economist, Olivier Blanchard. The Peterson report argues that concerns about structural problems were overdone. Growth in most major economies (excluding China) is not based on rising private or public leverage; even in China, service sector growth is rising to take over the declining role of manufacturing and trade imbalances are much lower than a decade ago.
Some of the Peterson report’s conclusions, particularly about China, are on the optimistic side about an economy beset by uncertainty. But it is correct in arguing that there was no reason for the market sell-off at the beginning of the year, and that it is wise to discount both the short-term volatility of financial markets and the more overheated critiques of central banks and finance ministries that emanate from them.
The IMF and the Peterson economists may have a different take on the resilience of the economy. But in terms of the appropriate policy response, they have a vital point of agreement. Both argue that policymakers - monetary and fiscal - must be prepared to increase stimulus further. They should not succumb to defeatism, nor to complaints in the financial markets that loose policy is creating distortions or doing more harm than good.
Such complaints take several forms, including the contention that central banks are setting borrowing costs “artificially low”, as though there were some natural level for policy interest rates. Another is that quantitative easing of the kind that the European Central Bank extended on Thursday distorts financial markets by compressing bond yields and raising equity prices. There may well be something in this, but it is surely better to have high stock prices than a crunching recession.
A final critique is that looser monetary policy is now a zero-sum game since it only works through weakening currencies. There is no doubt that the exchange-rate channel can be an important one, but it is by no means the only, or even the main, route by which QE stimulates the economy. The ECB, perhaps mindful of this criticism, structured its loosening this week to minimise the effect on the currency. A general international round of easing where appropriate is not necessarily a game of beggar-thy-neighbour if it ends up with global monetary conditions becoming easier.
How much momentum is in the recovery, and how far imbalances and structural problems threaten a lurch lower in growth, is intrinsically uncertain. What should command consensus is that the fiscal and monetary actions taken since the global financial crisis have helped the world economy return to at least a semblance of normality, and that policymakers must not give up now.
