The IMF has just published its 6-monthly World Economic Outlook report. The report is moderately optimistic, arguing that ‘global activity has broadly strengthened and is expected to improve further in 2014–15’. World growth is expected to rise from 3.0% in 2013 to 3.6% in 2014 and 3.9% in 2015,
Much of the impetus for an acceleration in growth is expected to come from advanced countries. Growth in these countries is expected to average 2¼% in 2014–15, a rise of 1 percentage point compared with 2013. Part of the reason is that these countries still have large output gaps and thus have considerable scope to respond to rises in aggregate demand.
Monetary policy in advanced countries remains accommodative, although the USA has begun to taper off its quantitative easing programme. It is possible, however, that the ECB may make its monetary policy more accommodative, with signs that it might embark on quantitative easing if eurozone growth remains weak and if the risks of deflation rise. If the average price level in the eurozone does fall, this could dampen demand as consumers defer consumption until prices have fallen.
As far as emerging economies are concerned, growth is projected to ‘pick up gradually from 4.7 percent in 2013 to about 5 percent in 2014 and 5¼% in 2015’. Although predicted growth is higher in emerging countries than in advanced countries, its acceleration is less, and much of the predicted growth is dependent on rising export sales to the advanced countries.
Global growth, however, is still fragile. Emerging market economies are vulnerable to a slowing or even reversal of monetary flows from the USA as its quantitative easing programme winds down. Advanced countries are vulnerable to deflationary risks. ‘The result [of deflation] would be higher real interest rates, an increase in private and public debt burdens, and weaker demand and output.’
The UK is predicted to have the strongest growth (2.9%) of the G7 countries in 2014 (see above chart). But the IMF cautions about being too optimistic:
Growth has rebounded more strongly than anticipated in the United Kingdom on easier credit conditions and increased confidence. However, the recovery has been unbalanced, with business investment and exports still disappointing.
Articles
IMF: World economy stronger; recovery uneven USA Today, Paul Davidson (8/4/14)
Emerging markets feel the pressure The Telegraph, Szu Ping Chan (8/4/14)
IMF cuts downturn danger to near zero Financial Times, Chris Giles (8/4/14)
IMF warns eurozone and ECB on deflation threat RTE News (8/4/14)
Recovery strong but risk shifts to emerging markets: IMF CNBC, Kiran Moodley (8/4/14)
IMF: World economy is stronger but faces threats Bloomberg Businessweek, Christopher S. Rugaber (8/4/14)
IMF: UK economic growth to reach 2.9% in 2014 BBC News (8/4/14)
IMF: UK economic growth to reach 2.9% in 2014 BBC News, Hugh Pym (8/4/14)
Five signs that the global economic recovery may be an illusion The Guardian, Larry Elliott (6/4/14)
Report and data
World Economic Outlook (WEO) International Monetary Fund (8/4/14)
World Economic Outlook Database IMF (8/4/14)
Questions
- Why does the IMF expect the world economy to grow more strongly in 2014 and 2015 than in 2013?
- What are the greatest risks to economic growth for (a) advanced countries; (b) developing countries?
- What geo-political events could negatively affect economic growth in (a) the eurozone; (b) the global economy?
- In what ways is the UK’s economic growth unbalanced?
- How much credence should be given to economic forecasts?
- Should countries’ economic performance be judged primarily by their growth in GDP?
In August 2012, the ECB president, Mario Draghi, said that the ECB would ‘do whatever it takes‘ to hold the single currency together and support the weaker economies, such as Greece, Portugal and Spain. At the same time, he announced the introduction of outright monetary purchases (OMTs), which would involve purchasing eurozone countries’ bonds in the secondary markets. There were no limits specified to such purchases, but they would be sterilised by the sale of other assets. In other words, they would not increase the eurozone money supply. But despite the fanfare when OMTs were announced, they have never been used.
Today, the eurozone economy is struggling to grow. The average annual growth rate across the eurozone is a mere 0.5%, albeit up from the negative rates up to 2013 Q3. GDP is still over 2% below the peak in 2008. Inflation is currently standing at 0.8%, well below the 2% target. The ECB’s interest rate (‘main refinancing operations rate’) is 0.25%.
The recovery is hindered by a strong euro. As the chart shows, the euro has been appreciating against the dollar. The euro exchange rate index has also been rising. This has made it harder for the eurozone countries to export.
So what can the ECB do to stimulate the eurozone economy? Other central banks, such as the Bank of England, the US Federal Reserve and the Bank of Japan have all had substantial programmes of quantitative easing. The ECB has not. Perhaps OMTs could be used without sterilisation. The problem here is that there are no eurozone bonds issued by the ECB and hence none that could be purchased, only the bonds of individual member countries. Buying bonds of weaker countries in the eurozone would be seen as favouring these countries and might create a moral hazard.
Reducing interest rates is hardly an option given that they are at virtually zero already. And expansionary fiscal policy in the weaker countries has been ruled out by having to stick to the bailout conditions for these countries, which require the pursuit of austerity policies.
One possibility would be to intervene in the foreign currency market by buying US and other countries’ bonds. This would drive down the euro and provide a stimulus to exports. This option is considered in the Jeffrey Frankel article.
Articles
Why the European Central Bank should buy American The Guardian, Jeffrey Frankel (13/3/14)
Draghi holds course in face of deflation threat Reuters, Paul Carrel and Leika Kihara (13/3/14)
ECB’s Draghi: Strong Euro Pulling Down Euro Zone Inflation Wall Street Journal, Christopher Lawton and Todd Buell (13/3/14)
Draghi Bolstering Guidance Seen as Convincing on Rates Bloomberg, Jeff Black and Andre Tartar (13/3/14)
ECB president Mario Draghi counters euro upswing Financial Times, Claire Jones (13/3/14)
Turning Japanese? Euro zone exporters must hope not Reuters, Neal Kimberley (14/3/14)
Prospect of ECB QE drives eurozone bond rally Financial Times, Laurence Mutkin (12/3/14)
Data
Statistical Data Warehouse ECB
Winter forecast 2014 – EU economy: recovery gaining ground European Commission: Economic and Financial Affairs DG
AMECO online European Commission: Economic and Financial Affairs DG
Questions
- Why is the ECB generally opposed to quantitative easing of the type used by other central banks?
- What is meant by ‘sterilisation’? Why does sterilisation prevent OMTs being classed as a form of quantitative easing?
- Would it be possible for OMTs to be used without sterilisation in such as way as to avoid a moral hazard for the highly indebted eurozone countries?
- Is the eurozone in danger of experiencing deflation?
- What are the dangers of deflation?
- Why does the ECB not cut its main refinancing rate below zero?
- If the ECB buys US bonds, what effect would this have on the euro/dollar exchange rate?
- Would purchasing US bonds affect the eurozone money supply? Explain.
- What other means are there of the ECB stimulating the eurozone economy? How effective would they be likely to be?
One of the reasons why it is so hard to forecast economic growth and other macroeconomic indicators is that economies can be affected by economic shocks. Sometimes the effects of shocks are large. The problem with shocks is that, by their very nature, they are unpredictable or hard to predict.
A case in point is the current crisis in Ukraine. First there was the uprising in Kiev, the ousting of President Yanukovich and the formation of a new government. Then there was the seizing of the Crimean parliament by gunmen loyal to Russia. The next day, Saturday March 1, President Putin won parliamentary approval to invade Ukraine and Russian forces took control of the Crimea.
On Monday 3 March, stock markets fell around the world. The biggest falls were in Russia (see chart). In other stock markets, the size of the falls was directly related to the closeness of trade ties with Russia. The next day, with a degree of calm descending on the Crimea and no imminent invasion by Russia of other eastern parts of Ukraine, stock markets rallied.
What will happen to countries’ economies depends on what happens as the events unfold. There could be a continuing uneasy peace, with the West effectively accepting, despite protests, the Russian control of the Crimea. But what if Russia invades eastern Ukraine and tries to annex it to Russia or promote its being run as a separate country? What if the West reacted strongly by sending in troops? What if the reaction were simply sanctions? That, of course would depend on the nature of those sanctions.
Some of the possibilities could have serious effects on the world economy and especially the Russian economy and the economies of those with strong economic ties to Russia, such as those European countries relying heavily on gas and oil imports from Russia through the pipeline network.
Economists are often criticised for poor forecasts. But when economic shocks can have large effects and when they are hard to predict by anyone, not just economists, then it is hardly surprising that economic forecasts are sometimes highly inaccurate.
What Wall Street is watching in Ukraine crisis USA Today (3/3/14)
Ukraine’s economic shock waves – magnitude uncertain Just Auto, Dave Leggett (7/3/14)
Ukraine: The end of the beginning? The Economist (8/3/14)
Russia will bow to economic pressure over Ukraine, so the EU must impose it The Guardian, Guy Verhofstadt (6/3/14)
Russia paying price for Ukraine crisis CNN Money, Mark Thompson (6/3/14)
Ukraine Crimea: Russia’s economic fears BBC News, Nikolay Petrov (7/3/14)
How Russia’s conflict with Ukraine threatens vital European trade links The Telegraph, Szu Ping Chan (8/3/14)
Will a Russian invasion of Ukraine push the west into an economic war? Channel 4 News, Paul Mason (2/3/14)
Who loses from punishing Russia? BBC News, Robert Peston (4/3/14)
Should Crimea be leased to Russia? BBC News, Robert Peston (7/3/14)
The Ukraine Economic Crisis Counter Punch, Jack Rasmus (7-9/3/14)
UK price rise exposes failure to prepare for food and fuel shocks The Guardian, Phillip Inman (2/3/14)
Questions
- What sanctions could the West realistically impose on Russia?
- How would sanctions against Russia affect (a) the Russian economy and (b) the economies of those applying the sanctions?
- Which industries would be most affected by sanctions against Russia?
- Is Russia likely to bow to economic pressure from the West?
- Should Crimea be leased to Russia?
- Is the behaviour of stock markets a good indication of people’s expectations about the real economy?
- Identify some other economic shocks (positive and negative) and their impact.
- Could the financial crisis of 2007/8 be described as an economic shock? Explain.
Finance ministers and central bank officials of the G20 countries are meeting in Sydney from 20 to 23 February. Business leaders from these countries are also attending and have separate meetings.
Amongst the usual discussions at such meetings about how to achieve greater global economic stability and faster and sustained economic growth, there are other more specific agenda issues. At the Sydney meeting these include a roundtable discussion to identify practical solutions to lift infrastructure investment. They also include discussions on how to clamp down on tax avoidance through means such as transfer pricing.
The G20 meetings of finance and business leaders take place annually. There are also annual summits of heads of government (the next being in Brisbane in November 2014).
The G20 was formed in 1999 to extend the work of the G8 developed countries to include other major developed and developing countries plus the EU. In 2008/9 it played a significant role in helping devise policies to tackle the banking crisis and combat the subsequent recession. At the time there was a common purpose, which made devising common policies easier.
Since then, the importance of the G20 has waned. Partly this is because of the divergent problems and issues between members and hence the difficulty of reaching agreements. Partly it is because, to be effective, it needs to remain small but, to be inclusive, it needs to extend beyond the current 20 members. Indeed there has been considerable resentment from many countries outside the G20 that their views are not being represented. Some representatives from non-G20 countries attend meetings on an informal basis.
The following articles discuss the role of the G20 and whether it is fit for purpose.
Articles
Janet Yellen vs. the world: The issues at the G20 finance summit Globe and Mail (Canada), Iain Marlow (20/2/14)
Turning ideas into action at the G20 Business Spectator (Australia), Mike Callaghan (21/2/14)
Boosting infrastructure investment can prove G20’s value to the world The Conversation, Andrew Elek (20/2/14)
Can the G20 ever realise its potential? The Conversation, Mark Beeson (21/2/14)
G20 has failed to fulfil its promise of collaboration amid hostility The Guardian, Larry Elliott (20/2/14)
Official G20 site
G20 Priorities G20
Australia 2014 G20
News G20
Questions
- Which countries are members of the G20? Compile a list of those countries you feel ought to be members of such an organisation.
- What are the arguments for and against increasing the membership of the G20 (or decreasing it)?
- Why is Janet Yellen, Chair of the US Federal Reserve, likely to be at odds with leaders from other G20 countries, especially those from developing countries?
- Why have the tensions between G20 members increased in recent months?
- Discuss possible reforms to the IMF and the G20’s role in promoting such reforms.
- What insights can game theory provide in understanding the difficulties in reaching binding agreements at G20 meetings? Are these difficulties greater at G20 than at G8 meetings?
- Should the G20 be scrapped?
In a speech in Edinburgh, Mark Carney, Governor of the Bank of England, considered the implications of Scotland retaining the pound if the Scottish people vote yes for independence. His speech was intended to be non-political. Rather he focused on two main questions: first whether a currency union of Scotland and the rest of the UK (RUK) would be an optimal currency area; second how much economic sovereignty would need to be shared with RUK as a consequence of Scotland keeping the pound.
On the first question, Mark Carney argued that the current UK is close to an optimal currency area as there is a high degree of economic integration and factor mobility. Sharing a currency eliminates exchange costs, improves pricing transparency and hence encourages competition, promotes cross-border investment, improves the flow of technology and ideas, and increases the mobility of labour and capital.
But sharing a currency involves sharing a monetary policy. This would still be determined by the Bank of England and would have to geared to the overall economic situation of the union, not the specific needs of Scotland.
There would also need to be a banking union, whereby banks in difficulties would receive support from the whole currency area. In Scotland’s case, banking accounts for a very large proportion of the 
economy (12.5% compared with 4.3% for RUK) and could potentially place disproportionate demands on the currency union’s finances.
And then there is the question of fiscal policy. A shared currency also means pooling a considerable amount of sovereignty over taxation, government spending and government debt. This could be a serious problem in the event of asymmetric shocks to Scotland and RUK. For example, if oil prices fell substantially, Scotland may want to pursue a more expansionary fiscal policy just at a time when its tax revenues were falling. This could put a strain on Scotland’s finances. This might then require RUK to provide support from a common pool of funds, such as a ‘regional fund’.
Being in a currency union can amplify fiscal stress, and increase both the risks and consequences of financial instability. In the situation just described [a fall in demand for exports], fiscal policy would ideally help smooth adjustment to the external shock. But its ability to do so could be limited by the budgetary impact of the falls in output, prices and wages. To maintain credibility, fiscal policy may even become pro-cyclical, with the resulting austerity exacerbating the initial fall in demand. In the extreme, adverse fiscal dynamics could call into question a country’s membership of the union, creating the possibility of self-fulfilling ‘runs’ on bank and sovereign debt absent central bank support.6 Such adverse feedback loops turned recessions into depressions in several European countries in recent years.
A separate Scottish currency, by contrast, would, according to Carney, be a valuable shock absorber if domestic wages and prices were sticky.
For example, suppose demand for a country’s exports falls. All else equal, its output will fall, unemployment increase and current account deteriorate. With an independent currency, exchange rate depreciation can dampen these effects by improving competitiveness, and monetary policy can become more accommodative, supporting demand and employment. However, if the country were part of a currency area with its foreign market, its exchange rate would by definition not change, putting the full weight of adjustment on wages and unemployment – a significantly more protracted and painful process. In addition, the responsiveness of monetary policy to weak demand in that country would be diluted by the needs of the broader membership.
But despite the problems of ceding a degree of monetary and fiscal sovereignty, Scotland and RUK are well placed to continue with a successful currency union if Scotland becomes independent. Economic conditions are very similar, as are language, culture and institutions, and there is an effective banking union – assuming such a banking union were to continue post independence.
The existing banking union between Scotland and the rest of the United Kingdom has proved durable and efficient. Its foundations include a single prudential supervisor maintaining consistent standards of resilience, a single deposit guarantee scheme backed by the central government, and a common central bank, able to act as Lender of Last Resort across the union, and also backed by the central government. These arrangements help ensure that Scotland can sustain a banking system whose collective balance sheet is substantially larger than its GDP.
The desirability of Scottish independence is a normative question for the Scottish electorate to decide. Nevertheless, economists have an important part to play in informing the debate. Mark Carney’s economic analysis of currency union if the Scottish electorate votes yes is a good example of this.
Video of speech
Speech at lunch hosted by the Scottish Council for Development & Industry, Edinburgh Bank of England, Mark Carney (29/1/14)
Text of speech
The economics of currency unions Bank of England, Mark Carney (29/1/14)
Articles, podcasts and webcasts
Independent Scotland would be forced to cede some sovereignty if it keeps pound, says Carney The Telegraph, Szu Ping Chan (29/1/14)
Scottish independence: Currency debate explained BBC News, Andrew Black (29/1/14)
Scottish independence: Key extracts from Mark Carney speech BBC News (29/1/14)
Scottish independence: Carney says Scots currency plan may lead to power loss BBC News (29/1/14)
The sterling price of Scottish independence BBC News, Robert Peston (29/1/14)
Independent Scotland ‘needs to cede sovereignty’ for currency union with UK The Guardian, Severin Carrell (29/1/14)
Mark Carney warns Scotland over currency union hopes Financial Times, Mure Dickie and Sarah O’Connor (29/1/14)
How independent would Scotland really be? Channel 4 News (29/1/14)
BoE’s Mark Carney in currency sovereignty warning The Scotsman, Tom Peterkin (30/1/14)
Carney Says Scotland Must Heed Euro Crisis in Pound Debate Bloomberg, Emma Charlton and Jennifer Ryan (29/1/14)
Independent Scotland ‘meets criteria’ for currency union BBC Today Programme, Gordon MacIntyre-Kemp and Iain Gray (29/1/14)
Scotland must play a high-stakes poker game with Westminster over the pound The Guardian Larry Elliott (12/2/14)
Questions
- What are the conditions necessary for a successful currency union?
- To what extent do Scotland and RUK meet these conditions?
- What are meant by asymmetric shocks? Give some examples of asymmetric shocks that could affect a Scotland–RUK currency union.
- Why is there a potential moral hazard in a whole currency union providing fiscal support to members in difficulties?
- Why is banking union such an important part of a successful currency union? What lessons can be learned here from the eurozone currency union?
- What constraints would currency union impose on Scottish fiscal policy? Would such constraints exist in an optimal currency area?
