Saturday 09 Oct 2021 | 13:23 | SYDNEY
Saturday 09 Oct 2021 | 13:23 | SYDNEY

Global economy: Gloomy optimism


Mark Thirlwell

2 October 2009 15:00

When G-20 leaders met in Pittsburgh last month, they awarded themselves a pat on the back:

When we last gathered in April, we confronted the greatest challenge to the world economy in our generation...At that time, our countries agreed to do everything necessary to ensure recovery, to repair our financial systems and to maintain the global flow of capital. It worked. Our forceful response helped stop the dangerous, sharp decline in global activity and stabilize financial markets.

The latest update to the IMF's World Economic Outlook (WEO) basically agrees with their conclusions on the efficacy of the policy response:

The global economy appears to be expanding again, pulled up by the strong performance of Asian economies and stabilization or modest recovery elsewhere...The triggers for this rebound are strong public policies across advanced and many emerging economies that have supported demand and all but eliminated fears of a global depression.

Industrial production, world trade, and retail sales have all staged a V-shaped turnaround, led by the economies of Emerging Asia:

 Source: IMF World Economic Outlook.

The IMF has now boosted its forecast for world growth this year by 0.3 percentage points, to a contraction of 1.1% (equivalent to a projected fall of 2.3% at market exchange rates) and has upped its forecast for 2010 by 0.6 percentage points to 3.1% (or 2.3% at market exchange rates). 

Compared to where the world economy was just several months ago, this is clearly good news. Yet overall, the new WEO does not make for a particularly happy read. This is because the Fund's prognosis for the kind of recovery now in store is quite gloomy. According to the IMF, '...the current rebound will be sluggish, credit constrained, and, for quite some time, jobless.'

Some of this pessimism comes from work the Fund has done looking at the effects on output of past financial crises (see Chapter 4 of the WEO), where it finds that typically the effects were large, negative and permanent, producing falling investment, higher unemployment and lower productivity. As a result, the Fund's medium-term projections for the world economy have global output on a much lower path than it was forecasting back in April 2007: 

Source: IMF World Economic Outlook.

The IMF also warns that policymakers now face a delicate balancing act in determining when and how to withdraw the massive fiscal and monetary stimulus they have had to deploy, since:

History suggests that both premature and/or delayed exits can be costly. For example, fiscal retrenchment and the US Federal Reserve’s doubling of reserve requirements during 1936-7 are blamed for helping to undercut a nascent recovery...premature tax hikes in 1997, along with an unfavourable external environment, were among the factors that seem to have contributed to pushing Japan into recession...some argue that the withdrawal of monetary accommodation after the bursting of the dot-com bubble was too slow, leaving easy conditions to fuel excessive risk taking and the subsequent house price boom.

This sort of gloomily optimistic view of the future is also on display in The Economist's latest survey of the world economy, which concludes:

The world economy will not...relive the 1930s. It should also avoid Japan’s lost decade of the 1990s. Instead, the future of many Western economies will look more like continental Europe in the 1980s, with large deficits, heavy public debts and stubborn unemployment.

As it notes in its opening section, the Economist's survey is something of a take on Mohamed El-Erian's increasingly popular concept of a 'New Normal' for the world economy. For some forecasters, however, the new normal may turn out to look not that different from the old.