Global economic outlook: getting used to lower global growth?
Economic Quarterly Report
- The global economy will continue to grow at around 3 per cent this year and next
- Possibilities for boosting the economy through budgetary or monetary policy are limited
- Political developments mean that effective economic policy is unlikely
- Our forecast is mainly surrounded by downside risks, such as (geo)political tensions
- Global growth is more likely to be lower than our current forecast than higher
The global economy is muddling along …
The global economy will continue to grow at around 3 per cent this year and next (figure 1, table 1). The slower growth rate this year is broad based. In 2017, the growth rate is mainly supported by a slight acceleration of growth in the US and Japan, and a modest recovery in Russia and Brazil after a deep recession. The economies of China, the UK and the eurozone on the other hand will probably slow somewhat next year.
In comparison to our last Economic Quarterly Report we have reduced our growth forecasts for the UK and the eurozone for 2017 by nearly 1 percentage point and ¼ of a percentage point respectively. This is mainly due to the result of the Brexit referendum. We also now expect growth in the Netherlands to be ½ a percentage point lower in 2017. Moreover, we have significantly downgraded our forecast for the US by ½ a percentage point and ¾ of a percentage point for 2016 and 2017 respectively, mostly due to the absence of any pick-up in business investment. We have been expecting the slowdown in growth in China for some time, and this is a consequence of the policy of transforming the economy from an investment-based economy built on debt into a services economy driven by consumption. This by the way is not necessarily a bad thing: the current growth model is indeed not sustainable.
… more risks to the downside than to the upside
At around 3 per cent, the rate of global economic growth is barely adequate. And there is a greater possibility that any surprises will be negative rather than positive. This is due among other things to (geo)political tensions around the South China Sea and in Europe, the US presidential elections, unrest in the Middle East, uncertainty concerning the Brexit process, the refugee crisis in Europe and growing doubts around the world regarding the effectiveness of the present (unconventional) monetary policy with no clear exit strategy. At the same time, there is little reason to believe that in the near future policymakers are prepared, willing and able to take control in order to boost economic growth and address the risks we have mentioned.
… and the policy instruments appear to be more or less exhausted
Limited options for stimulation via budgetary policy
Budgetary policy is unlikely to contribute to higher growth for various reasons. In Europe, governments are prevented from taking large-scale stimulative measures by the European budgetary rules, even though such measures might be advisable. In the US, the economy looks to be performing reasonably at its potential and an expansive budgetary policy would be procyclical. In China, a loose budgetary policy in the form of additional government investment would have little effect because government investment is generating hardly any return. Furthermore, the Chinese government wants to change the economic model away from an investment-based economy built on debt. It does however have tax cuts in the pipeline to bring an end to the contraction in private investment. Other Asian governments could see further debt build-up punished by the financial markets, certainly in countries with relatively high debt positions in foreign currencies, given the interest rate increase by the US Federal Reserve expected later this year or early next year. These countries anyway account for only a small proportion of global GDP, so that any boost to domestic demand would have only a limited effect on global economic growth.
Economic policy is negatively influenced by political developments
It looks unlikely that there will be any move by policymakers to boost economic growth in the short term. Support for populist and nationalist parties and leaders has increased in many countries in recent years. In the West, this increases the chance of more protectionist, nationalist and static economic policy, implying that reforms to make economies more productive will have lower priority. Upcoming referendums and elections in Europe are moreover encouraging politicians to delay taking action, since in the short term such reforms may have negative electoral consequences. A more protectionist policy means less chance of ground-breaking international trade treaties, which usually contribute to economic growth in the participating countries.
Meanwhile, populism in a number of emerging markets such as China, Russia and Turkey is leading to these countries adopting a more aggressive stance internationally. This increases the risk of international conflicts and limitations on international trade.
The challenges will not resolve themselves
The current support for populist politicians and the resulting implications for economic growth will not just go away. One reason for the increase in this support in many Western countries is the economic stagnation and the loss of income of large groups among the middle classes in recent decades. The outlook for growth in various countries is too modest for this to be forgotten in the short term. The refugee crisis is another cause of increasing populism in Europe, as it is strengthening anti-immigration and anti-EU views for various reasons. It is unlikely that the refugee crisis will disappear into the background any time soon.It is actually more likely to become worse, since the deal with Turkey on refugees is falling apart and the unrest in the Middle East is continuing and even becoming more severe.
Side-effects of monetary policy possibly more damaging than positive effects
Accommodative monetary policy has contributed to the recovery of the global economy in recent years. However, it is unlikely that further monetary accommodation will be a solution to the current limited level of global economic growth. In economies such as Japan and the eurozone, what is known as the transmission of monetary policy to the real economy is actually far from optimal. Also in China positive effects of further monetary easing would be limited, but in this case mainly because of the low profitability of additional investment by state-owned enterprises and local governments. Emerging markets in Asia have some room to ease monetary policy, but they want to use this as a buffer against continuing headwinds, including the imminent interest rate hike in the United States.
There is also virtually no coordination any more between policymakers around the world. The result is that policymakers in various countries are continually competing with each other to boost exports by lowering their exchange rates with ultimately no permanent improvement in economic growth. There is a considerable risk that lengthy continuation of the current course of monetary policy or further easing is ultimately more likely to damage the economy than to improve it.
The risks of the current course of monetary policy
The financial markets, policymakers and economies have now become addicted to further declines in interest rates (figure 2). And, with policy rates at around zero for some considerable time and huge increases in the balance sheets of the central banks, there is a real risk of new bubbles and imbalances. Ultimately this policy is not sustainable, but nobody has a scenario for getting out of this stalemate. Expansionary monetary policy in the form of low interest rates moreover means that structural reforms that would boost growth, for example in the eurozone and Japan, are being postponed. Low interest rates are reducing the pressure on politicians to take decisive economic measures that may well be painful in the short term.
Rather than implementing reforms, policymakers in various parts of the world are relying excessively on accommodative monetary policy. This is not only ineffective, it involves risks as well.
Looking ahead: what’s next?
The prospect for growth is currently moderate at best. Economic growth is not only low in historical terms, it is also not enough to generate sufficient income to reduce income inequality and poverty in large parts of the world, swiftly repair the losses suffered by the middle class in the West as a result of the crisis, reduce the high level of unemployment in parts of Europe or have any substantial impact on reducing the mountain of debt in the Southern EU member states and a number of emerging markets in Asia. To boost growth, different policy options are needed.
A coordinated approach to monetary policy is needed. A large-scale ‘global revision’ of monetary policy could reverse the continuing decline in interest rates and the risks associated with this. To avoid a collapse of economic growth, this needs to be accompanied by an easing of budgetary policy where this is possible, such as in the eurozone. Certainly in countries running large and permanent current account surpluses. Policymakers could also increase the potential for growth by reforming labour and product markets and by focusing more on innovation and technological progress.
The Economic Quarterly is a publication of Economic Research of Rabobank and a co-production with Financial Markets Research. The date of completion is the 6th of September 2016.
The views presented in this publication are based on data from sources we consider to be reliable. Among others, these include Macrobond. The economic growth forecasts are generated from the NiGEM global econometric structure models.
This data has been carefully incorporated into our analyses. Rabobank accepts, however, no liability whatsoever should the data or prognoses presented in this publication contain any errors. The information concerned is of a general nature and is subject to change.
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Abbreviations for sources: CBS: Statistics Netherlands, ONS: Office of National Statistics, OECD: Organisation for Economic Co-operation and Development, CPB: Economic Policy Analysis, IMF: International Monetary Fund, ECB: European Central Bank, BoE: Bank of England, BoJ: Bank of Japan, Fed: Federal Reserve.
Abbreviations used for countries/regions: UK: United Kingdom, US: United States, JP: Japan, EZ: eurozone.
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