Raising World Economy’s Speed Limit Emerges as ChallengeSimon Kennedy
Global finance chiefs are trying to soup up their crisis-hit economic engines.
How to do so was a theme of weekend talks of the International Monetary Fund’s spring meetings in Washington as economists from JPMorgan Chase & Co. estimate the financial crisis and subsequent world recession knocked the potential growth rate of rich countries down to about 1.5 percent from 2 percent.
Such a decline in the speed limit of the growth rate at which inflation ignites is troubling because it risks pressuring central banks to raise interest rates sooner than they might otherwise want. The weaker potential also hurts the ability of businesses to boost profits, workers to win pay increases and governments to cut debts.
“It is clear to me and not just to the IMF but many other players around the world that there is a real significant potential” to be tapped, IMF Managing Director Christine Lagarde told Bloomberg Television’s Tom Keene in Washington.
The debate marks a pivot after six years of worrying over how to spur demand to considering how to increase the supply side of economies so they can handle faster expansion. While growth rates for a time can exceed potential -- which is determined by the growth of the labor force and of worker productivity -- it cannot do so for an extended period. The IMF predicts advanced nations will grow faster than 2 percent this year for the first time since 2010.
“Driving growth that creates jobs and raises living standards is now the top priority for the global community, and that focus marks a turning point in the global recovery,” U.S. Treasury Secretary Jacob J. Lew said. Singapore Finance Minister Tharman Shanmugaratnam said there is now “a focus on the medium term more than the short term, and a much greater focus on structural reforms.”
The challenge they face was illustrated in a Washington presentation by Bruce Kasman, chief economist at JPMorgan. His estimates show the potential rate of developed economies is about 5.2 percent of gross domestic product below what it would have been had the 2008 trend held intact. In a sign demand still remains weak, the new trend is still about 4 percent of GDP above current performance.
What Kasman called a “chronic supply-side crisis” was evident in other calculations which showed the proportion of the working age population in jobs has slid to about 54 percent from almost 56 percent before the crisis. Investment as a share of GDP has dropped to about 20 percent from about 22 percent.
Putting another name to the outlook is former U.S. Treasury Secretary Lawrence Summers, who has revived the term “secular stagnation” as a warning of what may await rich nations if their governments fail to invest more to increase the capacities of their economies. Low borrowing costs and double-digit unemployment for construction workers suggest no obstacle to the U.S. government spending on infrastructure, he argues.
“A soft economy casts a substantial shadow forward onto the economy’s future output and potential,” Summers said April 1.
After spending recent years advocating stimulus, the IMF is also tuning into the supply-side weaknesses. In speeches and reports over the last week, its officials argued weaker trend expansion would make it harder for governments to restore fiscal order and that a failure to revive investment or mop up the supply of workers would spell permanent economic weakness.
Possible solutions include revamping how labor markets work, increasing competition and productivity in non-tradable sectors, paring the size of governments and looking to improve state spending, IMF chief economist Olivier Blanchard said. The lender estimated in February that reforms could add $2.25 trillion to the global economy by 2018.
“There’s no easy way to grow the world economy,” said Australian Treasurer Joe Hockey. “Easy monetary policy is inevitably sooner or later going to end and governments haven’t got the fiscal capacity to keep throwing money. The third leg to the stool has to be structural reform, and that’s not politically easy, it’s hard.”
Not all are worried. U.K. Chancellor of the Exchequer George Osborne recommitted to fiscal austerity and rejected Summers’s case for more government spending.
“The pessimists are on the march again with their predictions of stagnation,” he said. “We, the optimists, can prove them wrong again.”
Central bankers in Washington also trained their eyes on the lack of current demand, as represented by the gap between potential and actual growth. Bank of Canada Governor Stephen Poloz said the gap’s existence is “pushing inflation lower than our traditional model would expect.”
That doesn’t mean monetary policy makers aren’t worried about where their economies’ cruising speed is.
At the Federal Reserve, the central tendency of forecasts for long-run growth fell to 2.2 percent to 2.3 percent in March from 2.3 percent to 2.5 percent a year ago.
While the European Central Bank doesn’t estimate a potential growth rate, the European Commission warned in January that the euro area’s will be about half that of the decade before the debt crisis at just above 1 percent.
The lower the potential rate “the more likely you have a rapid rate hike,” said Adam Posen, a former U.K. monetary policy maker and now president of the Peterson Institute for International Economics in Washington. It would also probably mean authorities would signal their benchmarks would peak at lower levels than historically.
Some central bankers suggest if they can revive demand that will have a supply-side payoff. Bank of England Governor Mark Carney wants to encourage companies to invest more so as to help boost worker productivity, while the Fed is trying to draw discouraged workers back into the labor pool.
“With a delay, there is finally a debate on whether the U.S., and the world’s potential growth rate, has been compromised by the global financial crisis,” said Stephen Jen, co-founder of SLJ Macro Partners LLP in London and a former IMF economist.