How Fast Can the Global Economy Go?

The global economy’s potential growth rate, a kind of speed limit, is ticking up

By Richard Barley


UNDERLYING RECOVERY
Measures of growth in large advanced economies

Source: International Monetary Fund


The world economy has found the accelerator pedal of late. But for policy makers and markets, an important question is what is happening to potential growth, a sort of speed limit for the economy.

Global growth is set to reach 3.9% in 2018 on the International Monetary Fund’s latest numbers out Tuesday, boosted by stronger expansion in advanced economies and the fastest since 2011. The good news is that the IMF thinks only 40% of the better-than-expected growth in advanced economies in 2016 and 2017 relative to its 2016 forecasts is down to a cyclical rise in demand, with the rest down to higher potential growth.


That implies the expansion is more sustainable: it isn’t all down to a surge in demand, but also reflects expanded supply. It helps explain the way in which inflation hasn’t risen much even as growth has accelerated and unemployment has fallen: a combination that has been extremely good for investors.

In all, the IMF estimates potential growth has picked up by 0.4 percentage point between 2011 and 2017 for 10 large advanced economies--the Group of Seven plus Australia, South Korea and Spain--to about 1.6%. That remains well below pre-crisis levels of 2% to 2.5% because the contribution of labor and capital stocks to potential growth remains weak. Demographic headwinds, in particular, may weigh on growth.


An employee works in front of the blast furnace at a steel mill in Germany. Photo: Alexander Koerner/Getty Images 


This debate might seem arcane in a world worried about a trade war between the U.S. and China, and geopolitical clashes with Russia. But the underlying strength and persistence of growth and the stability of inflation are vital factors supporting the relative health of markets lately.

The message that potential growth has recovered a little is encouraging, but investment is the thing to watch. Without it, the world economy might be stuck in the slow lane.

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