Friday, November 28, 2014

The Global Economy’s Groundhog Day

NEW DELHI – In the movie “Groundhog Day,” a television weatherman, played by Bill Murray, awakes every morning at 6:00 to relive the same day. A similar sense of déjà vu has pervaded economic forecasting since the global economic crisis began a half-decade ago. Yet policymakers remain convinced that the economic-growth model that prevailed during the pre-crisis years is still their best guide, at least in the near future.

Consider the mid-year update of the International Monetary Fund’s World Economic Outlook, which has told the same story every year since 2011: “Oops! The world economy did not perform as well as we expected.” The reports go on to blame unanticipated factors – such as the Tōhoku earthquake and tsunami in Japan, uncertainty about America’s exit from expansionary monetary policy, a “one-time” re-pricing of risk, and severe weather in the United States – for the inaccuracies.

Emphasizing the temporary nature of these factors, the reports insist that, though world GDP growth amounted to roughly 3% during the first half of the year, it will pick up in the second half. Driven by this new momentum, growth will finally reach the long-elusive 4% rate next year. When it does not, the IMF publishes another rendition of the same claims.

This serial misjudgment highlights the need to think differently. Perhaps the focus on the disruptions caused by the global financial crisis is obscuring a natural shift in developed economies to a lower gear following years of pumped-up growth. Moreover, though emerging economies are also experiencing acute growth slowdowns, their share of the global economic pie will continue to grow. In short, tougher economic competition, slower growth, and low inflation may be here to stay.

In the United States, conditions for an economic takeoff ostensibly have been present for the last year. Household debt and unemployment have fallen; corporate profits and cash reserves are large; the stock market is valuing the future generously; banks are ready to lend; and fiscal consolidation is no longer hampering demand.

Yet, contrary to expectations, growth in household consumption has remained lackluster, and businesses have not ramped up investment. In the first two quarters of this year, America’s GDP barely exceeded the level it attained at the end of last year, and much of the increase was driven by goods that have been produced but not yet sold. The prevailing explanation – a brutally cold winter – is wearing so thin that everyone should be able to see through it.

American consumers remain scarred by the crisis. But there is another problem: in their homes and workplaces, the sense of excitement about the future is missing, despite all the gee-whiz gadgetry that now surrounds them. And while the US Federal Reserve’s policy of quantitative easing has propped up businesses, it is no substitute for the enthusiasm and anticipation needed to propel investment.

Even the reduced global forecast of 3.4% GDP growth for this year is likely to prove excessively optimistic. Before the crisis, world trade grew at 6-8% annually – well faster than GDP. But, so far this year, trade growth remains stuck at about 3%.

Failure to recognize the fundamental slowdown that is occurring is reinforcing the expectation that old models can revive growth – an approach that will only create new fragilities. Atif Mian and Amir Sufi warn that US consumers’ purchases of cars and other durables have been bolstered by the same unsustainable “subprime” lending practices that were used to finance home purchases before the crisis.

Similarly, Mark Carney, Governor of the Bank of England, envisages a Britain with a Cyprus-sized financial sector amounting to 900% of GDP. And economist Michael Pettis cautions that China’s reliance on policy stimulus to kick-start the economy whenever it stalls will merely cause macroeconomic vulnerabilities to accumulate.

The two tectonic shifts in the global economy – slower GDP growth and increased emerging-market competition – have created a fault line that runs through Europe. The technical lead held by Europe’s traditional trading economies is being eroded, while wage competition is encouraging fears of deflation. And, with the eurozone’s most debt-burdened economies bearing the brunt of these shifts, Italy is sitting directly atop the fault.

The European Central Bank, however, is unable to revive eurozone growth on its own. Given the resulting drag on the global economy – and especially on world trade – it is in the world’s interest to engineer a coordinated depreciation of the euro. At the same time, a globally coordinated investment stimulus is needed to create new opportunities for growth.

Just as Bill Murray’s character could not escape Groundhog Day without radically changing his life, we cannot expect different economic outcomes without fundamentally different growth models.

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    1. CommentedVan Poppel charles

      Again a professor of economics criticizing nearly everyone , including the FED, but without offering a positive suggestion : how to prop up demand from consumers , which would incite entrepreneurs to invest and increase employment , which would increase tax revenues to lower the public debt in an environment of low inflation. If the countries of the euro zone continue to apply an austeriy policy à la Mr REHN, European commissioner for economic affairs, meaning not to stimulate consumer expenditure but even raising taxes to reduce the budget deficit during this crisis period, we are gone for a slowing of economic growth notwithstanding the ultra accommodating monetary management of the ECB and the FED because of this austerity policy economic agents refuse to use this "credit boom" offered by these the central banks, for economic expansion. Every weakening of consumer demand brings a weakening demand for capital leading to lower economic growth.

    2. Commentedjim bridgeman

      What if things like inflation and deflation, growth and stagnation, are effects rather than causes of the public moods and attitudes?

    3. CommentedMargaret Bowker

      Patience, resilience and not expecting institutions to forecast exactly what is going to happen seems the sensible way to deal with the recovery half of the recession. The Central banks have general, adjustable policy. When improvement in growth doesn't necessarily trickle down to wages it rightly slows down action on rates and other tightening measures . This was a most significant recession, so it needs time to work its way through to full recovery and commentary will be repeated. As Ashoka Mody says, there is at present a new reality in rates, inflation and growth. The ECB will launch QE, perhaps in the Autumn, and with Japan's stimulus balance out the slight tightening in UK and US during the course of next year. Patience and no steps backward.

    4. CommentedGerry Hofman

      "It is in the world’s interest to engineer a coordinated depreciation of the euro"... I suppose the author means 'Its in the interest of America to engineer a depreciation of the Euro', because that is the only way it could turn out to be. Whether anybody in the US would be prepared to interfere in the financial markets in this way is very doubtful, as it would mean a wholesale conversion away from current economic belief systems. This comment is arrogant if not completely stupid. If such a move were even possible it would mean a complete abandonment of current economic dogma as well as a complete breakdown of international politics.

    5. CommentedRobert Bostick

      How ironic is it that a growing economy, surprise, surprise needs a growing supply of money. In the U.S. the false premise that Obama repeats to often, "we're out of money" is also a canard, since he's aware that the U.S. is the sole issuer of its own currency. Yet, he and congressional austerians deny the validity of monetary sovereignty as a fundamental precept in the management of American fiscal and monetary alternatives.

    6. CommentedProcyon Mukherjee

      How could we possibly think that policy makers would have such a perfect view of the world that it would make such a success out of coordinated actions either in depreciation of the Euro or the coordinated stimulus, when we see such a great divide in our thinking (of what works and what does not) feature in every mundane debate. It would be naive to imagine that the European fault line has such a trivial solution in the depreciation of its currency or that we need such a continuation of an ever-growing stimulus that drawing from the future becomes the only stately advice.