IMF faces sluggish growth but no genuine recovery
October 7, 2012 3:12 pm
by Gavyn Davies
The Annual Meetings of the IMF and the World Bank take place in Tokyo this week, and as always they provide a good opportunity to take stock of the condition of the global economy, and of economic policy.
There is much less of a crisis atmosphere surrounding this week’s meetings than there was a year ago, largely because the actions of the ECB have succeeded in calming the eurozone storm for the time being.
However, there have been significant downgrades to growth prospects in China and India in the past year, and growth in the major developed economies has been extremely unsatisfactory.
The IMF’s economic projections, which show global real GDP growth running at around 4.5 per cent per annum over the medium term, are looking increasingly difficult to reach. Certainly, the latest projections, released in July, appear likely to be downgraded. For example, the IMF forecast for GDP growth in 2013, which was as high as 3.9 per cent in the July projection, is around a full percentage point higher than the latest average forecast from the major investment banks.
On a brighter note, however, the risk that the global economy is actually sliding towards a renewed recession seems to have diminished in recent weeks, and the data published for September indicate that growth has probably passed the low point for the latest mini cycle. Sluggish growth, but no recession, is likely to be the IMF’s message from Tokyo this week.
When examining the impact of global GDP growth on financial markets, it is useful to separate the big picture, measured in years, from the mini cycle, measured in months or quarters. At present, the big picture looks very unsatisfactory, but the mini cycle has touched bottom. It is the latter which has been underpinning risk assets since last June.
The worrying state of the big picture for global growth is captured by the following graph, which shows the behaviour of the output gaps in the major developed economies in recent years (estimated using OECD methodology):
The developed economies have become caught in a low growth trap where the margin of spare capacity is either remaining broadly unchanged (as in the US case), or is actually increasing (as in the eurozone and the UK). Only in Japan is the output gap narrowing, and that is mainly because the trend growth in real GDP has fallen to such low levels: it is a low hurdle to clear.
I am sure that many people will say the output gap is an artificial construct which is impossible to measure accurately in real time. That is true, but the basic point is clear. Of all the major developed economies, only Germany and Canada have managed to get their real GDP levels above the pre-recession levels of 2007. No economy has returned to anywhere near the pre-2007 trendline for real GDP, extrapolated to the present.
A couple of years ago, many forecasters assumed that much of the shortfall in real GDP, relative to previous trends, would be eliminated over a few years, as growth rates rebounded in the manner which normally happens following a recession. In fact, some said that the rebound might prove to be more rapid than normal, simply because the decline during the recession had been so large. None of that now seems tenable.
Instead, the bleak arithmetic made famous by Reinhart and Rogoff, which showed that the growth rate following a major financial crash would remain very subdued for a long time, seems to have taken hold. The central banks have taken extraordinary steps to ensure that “this time is different”, but their efforts have been mostly cancelled out by a combination of fiscal tightening from 2010 onwards, and an unknown amount of supply side shrinkage in economic capacity. Christine Lagarde, the IMF Managing Director, has repeatedly asked for government action to match that of the central banks, and she will doubtless do so again this week. It is unlikely to be forthcoming.
Why then, have the markets been in reasonably good shape while all this has become clear this year?
I would suggest two reasons. The first is that consensus opinion no longer expects a sharp recovery in growth rates in the developed economies in the years ahead. The accompanying graph shows how consensus forecasts for growth have changed in the US, and this chartpack shows similar graphs for all the major economies. The key point is that the large downgrades to growth projections occurred in the second half of 2011, since when growth in the G7 has come in as bad as expected but no worse. Outside the developed economies, the most important downgrades have come in China, where the stockmarket has of course underperformed.
The second reason is that the mini cycle in global growth rates, which was clearly headed downwards in the first half of 2012, has stabilised in the third quarter, and has headed into recovery territory in September. The final chart shows the performance of some key activity indicators which capture inflexion points in the mini cycle:
It is clear that low point was reached in May or June. This is confirmed by economists at J.P. Morgan, who have recently started to produce a weekly “nowcast” of global GDP growth, calculated by extracting the common growth factor from all of the major pieces of economic information published each month around the world. This is extremely useful for tracking likely changes in global GDP growth in real time. This week, Bruce Kasman, Joseph Lupton and David Hensley report that the implied global GDP growth rate has risen from 1.2 per cent in June to 1.9 per cent in September.
This is no real cause for celebration, except that it does clearly reduce the “left tail” risk of a renewed global recession. The mini cycle now looks likely to head upwards for a while, as it did at a similar time of year in 2010 and 2011.
Nevertheless, as the world’s key policy makers gather in Tokyo this weekend, the much bigger task, of turning this bounce into a sustained recovery, looks as far away as ever.