The International Monetary Fund has just published its six-monthly World Economic Outlook (WEO). The publication assesses the state of the global economy and forecasts economic growth and other indicators over the next few years. So what is this latest edition predicting?
Well, once again the IMF had to adjust its global economic growth forecasts down from those made six months ago, which in turn were lower than those made a year ago. As Larry Elliott comments in the Guardian article linked below:
Every year, economists at the fund predict that recovery is about to move up a gear, and every year they are disappointed. The IMF has over-estimated global growth by one percentage point a year on average for the past four years.
In this latest edition, the IMF is predicting that growth in 2015 will be slightly higher in developed countries than in 2014 (2.0% compared with 1.8%), but will continue to slow for the fifth year in emerging market and developing countries (4.0% in 2015 compared with 4.6% in 2014 and 7.5% in 2010).
In an environment of declining commodity prices, reduced capital flows to emerging markets and pressure on their currencies, and increasing financial market volatility, downside risks to the outlook have risen, particularly for emerging market and developing economies.
So what is the cause of this sluggish growth in developed countries and lower growth in developing countries? Is lower long-term growth the new norm? Or is this a cyclical effect – albeit protracted – with the world economy set to resume its pre-financial-crisis growth rates eventually?
To achieve faster economic growth in the longer term, potential national output must grow more rapidly. This can be achieved by a combination of more rapid technological progress and higher investment in both physical and human capital. But in the short term, aggregate demand must expand sufficiently rapidly. Higher short-term growth will encourage higher investment, which in turn will encourage faster growth in potential national output.
But aggregate demand remains subdued. Many countries are battling to cut budget deficits, and lending to the private sector is being constrained by banks still seeking to repair their balance sheets. Slowing growth in China and other emerging economies is dampening demand for raw materials and this is impacting on primary exporting countries, which are faced with lower exports and lower commodity prices.
Quantitative easing and rock bottom interest rates have helped somewhat to offset these adverse effects on aggregate demand, but as the USA and UK come closer to raising interest rates, so this could dampen global demand further and cause capital to flow from developing countries to the USA in search of higher interest rates. This will put downward pressure on developing countries’ exchange rates, which, while making their exports more competitive, will make it harder for them to finance dollar-denominated debt.
As we have seen, long-term growth depends on growth in potential output, but productivity growth has been slower since the financial crisis. As the Foreword to the report states:
The ongoing experience of slow productivity growth suggests that long-run potential output growth may have fallen broadly across economies. 
Persistently low investment helps explain limited labour productivity and wage gains, although the joint productivity of all factors of production, not just labour, has also been slow. Low aggregate demand is one factor that discourages investment, as the last World Economic Outlook report showed. Slow expected potential growth itself dampens aggregate demand, further limiting investment, in a vicious circle.
But is this lower growth in potential output entirely the result of lower demand? And will the effect be permanent? Is it a form of hysteresis, with the effect persisting even when the initial causes have disappeared? Or will advances in technology, especially in the fields of robotics, nanotechnology and bioengineering, allow potential growth to resume once confidence returns?
Which brings us back to the short and medium terms. What can be done by governments to stimulate sustained recovery? The IMF proposes a focus on productive infrastructure investment, which will increase both aggregate demand and aggregate supply, and also structural reforms. At the same time, loose monetary policy should continue for some time – certainly as long as the current era of falling commodity prices, low inflation and sluggish growth in demand persists.
Articles
Uncertainty, Complex Forces Weigh on Global Growth IMF Survey Magazine (6/10/15)
A worried IMF is starting to scratch its head The Guardian, Larry Elliott (6/10/15)
Storm clouds gather over global economy as world struggles to shake off crisis The Telegraph, Szu Ping Chan (6/10/15)
Five charts that explain what’s going on in a miserable global economy right now The Telegraph, Mehreen Khan (6/10/15)
IMF warns on worst global growth since financial crisis Financial Times, Chris Giles (6/10/15)
Global economic slowdown in six steps Financial Times, Chris Giles (6/10/15)
IMF Downgrades Global Economic Outlook Again Wall Street Journal, Ian Talley (6/10/15)
WEO publications
World Economic Outlook, October 2015: Adjusting to Lower Commodity Prices IMF (6/10/15)
Global Growth Slows Further, IMF’s latest World Economic Outlook IMF Podcast, Maurice Obstfeld (6/10/15)
Transcript of the World Economic Outlook Press Conference IMF (6/10/15)
World Economic Outlook Database IMF (October 2015 edition)
Questions
- Look at the forecasts made in the WEO October editions of 2007, 2010 and 2012 for economic growth two years ahead and compare them with the actual growth experienced. How do you explain the differences?
- Why is forecasting even two years ahead fraught with difficulties?
- What factors would cause a rise in (a) potential output; (b) potential growth?
- What is the relationship between actual and potential economic growth?
- Explain what is meant by hysteresis. Why may recessions have a permanent negative effect, not only on trend productivity levels, but on trend productivity growth?
- What are the current downside risks to the global economy?
- Why have commodity prices fallen? Who gains and who loses from lower commodity prices? Does it matter if falling commodity prices in commodity importing countries result in negative inflation?
- To what extent can exchange rate depreciation help commodity exporting countries?
- What is meant by the output gap? How have IMF estimates of the size of the output gap changed and what is the implication of this for actual and potential economic growth?
Real GDP depends on two things: output per hour worked and the number of hours worked. On the surface, the UK economy is currently doing relatively well, with growth in 2014 of 2.8%. After several years of poor economic growth following the financial crisis of 2007/8, growth of 2.8% represents a return to the long-run average for the 20 years prior to the crisis.
But growth since 2010 has been entirely due to an increase in hours worked. On the one hand, this is good, as it has meant an increase in employment. In this respect, the UK is doing better than other major economies. But productivity has not grown and on this front, the UK is doing worse than other countries.
The first chart shows UK output per hour worked (click here for a PowerPoint). It is based on figures released by the ONS on 1 April 2015. Average annual growth in output per hour worked was 2.3% from 2000 to 2008. Since then, productivity growth has stalled and output per hour is now lower than at the peak in 2008.
The green line projects from 2008 what output per hour would have been if its growth had remained at 2.3%. It shows that by the end of 2014 output per hour would have been nearly 18% higher if productivity growth had been maintained.
The second chart compares UK productivity growth with other countries (click here for a PowerPoint). Up to 2008, UK productivity was rising slightly faster than in the other five countries illustrated. Since then, it has performed worse than the other five countries, especially since 2011.
Productivity growth increases potential GDP. It also increases actual GDP if the productivity increase is not offset by a fall in hours worked. A rise in hours worked without a rise in productivity, however, even though it results in an increase in actual output, does not increase potential output. If real GDP growth is to be sustained over the long term, there must be an increase in productivity and not just in hours worked.
The articles below examines this poor productivity performance and looks at reasons why it has been so bad.
Articles
UK’s sluggish productivity worsened in late 2014 – ONS Reuters (1/4/15)
UK productivity growth is weakest since second world war, says ONS The Guardian, Larry Elliott (1/4/15)
UK productivity weakness worsening, says ONS Financial Times, Chris Giles (1/4/15)
Is the UK’s sluggish productivity a problem? Financial Times comment (1/4/15)
UK manufacturing hits eight-month high but productivity slump raises fears over sustainability of economic recovery This is Money, Camilla Canocchi (1/4/15)
Weak UK productivity unprecedented, ONS says BBC News (1/4/15)
Weep for falling productivity Robert Peston (1/4/15)
UK’s Falling Productivity Prevented A Massive Rise In Unemployment Forbes, Tim Worstall (2/4/15)
Data
Labour Productivity, Q4 2014 ONS (1/4/15)
AMECO database European Commission, Economic and Financial Affairs
Questions
- How can productivity be measured? What are the advantages and disadvantages of using specific measures?
- Draw a diagram to show the effects on equilibrium national income of (a) a productivity increase, but offset by a fall in the number of hours worked; (b) a productivity increase with hours worked remaining the same; (c) a rise in hours worked with no increase in productivity. Assume that actual output depends on aggregate demand.
- Is poor productivity growth good for employment? Explain.
- Why is productivity in the UK lower now than in 2008?
- What policies can be pursued to increase productivity in the UK?
With the publication of the February 2014 Inflation Report the Bank of England has adjusted its forward guidance to the markets.
As we saw in Part 1 of this blog, the economy should soon fall below the 7% unemployment threshold adopted in the original forward guidance issued last August. But the Bank feels that there is still too much slack in the economy to raise interest rates when unemployment does fall below 7%.
The Bank has thus issued a new vaguer form of forward guidance.
The MPC’s view is that the economy currently has spare capacity equivalent to about 1%–1½% of GDP, concentrated in the labour market. Around half of that slack reflects the difference between the current unemployment rate of 7.1% and an estimate of its
medium-term equilibrium rate of 6%–6½%. The remaining slack largely reflects a judgement that employees would like to work more hours than is currently the case. Companies appear to be operating at close to normal levels of capacity, although this is subject to some uncertainty.
The existence of spare capacity in the economy is both wasteful and increases the risk that inflation will undershoot the target in the medium term. Moreover, recent developments in inflation mean that the near-term trade-off between keeping inflation close to the target and supporting output and employment is more favourable than at the time the MPC announced its guidance last August: CPI inflation has fallen back to the 2% target more quickly than anticipated and, with domestic costs well contained, is expected to remain at, or a little below, the target for the next few years. The MPC therefore judges that there remains scope to absorb spare capacity further before raising Bank Rate.
Just what will determine the timing and pace of tightening? The Bank identifies three factors: the sustainability of the recovery; the extent to which supply responds to demand; and the evolution of cost and price pressures. But there is considerable uncertainty about all of these.
Thus although this updated forward guidance suggests that interest rates will not be raised for some time to come, even when unemployment falls below 7%, it is not at all clear when a rise in Bank Rate is likely to be, and then how quickly and by how much Bank Rate will be raised over subsequent months. Partly this is because of the inevitable uncertainty about future developments in the economy, but partly this is because it is not clear just how the MPC will interpret developments.
So is this new vaguer forward guidance helpful? The following articles address this question.
Articles
Bank of England Governor Carney’s statement on forward guidance Reuters (12/2/14)
Why has Mark Carney tweaked forward guidance? The Telegraph, Denise Roland (12/2/14)
Interest rates: Carney rips up ‘forward guidance’ policy Channel 4 News (12/2/14)
Forward guidance version 2: will the public believe it? The Guardian, Larry Elliott (12/2/14)
Mark Carney adjusts Bank interest rate policy BBC News (12/2/14)
Mark Carney’s almost promise on rates BBC News, Robert Peston (12/2/14)
Did the Bank of England’s Forward Guidance work? Independent, Ben Chu (2/2/14)
Forward Guidance 2.0: Is Carney just digging with a larger shovel? Market Watch, The Tell (12/2/14)
The U.K. Economy: Five Key Takeaways Wall Street Journal, Alen Mattich (12/2/14)
Bank of England pages
Inflation Report, February 2014 Bank of England (12/2/14)
Monetary Policy Bank of England
MPC Remit Letters Bank of England
Forward Guidance Bank of England
Questions
- Summarize the new forward guidance given by the Bank of England.
- Why is credibility an important requirement for policy?
- What data would you need to have in order to identify the degree of economic slack in the economy?
- Why is it difficult to obtain such data – at least in a reliable form?
- What is meant by the ‘output gap’? Would it be a good idea to target the output gap?
- Is it possible to target the rate of inflation and one or more other indicators at the same time? Explain.
In the third and final part of this blog, we look at the G8 summit at Camp David on 18 and 19 May 2012. Ways of averting the deepening global economic crisis were top of the agenda.
In terms of the global economy, the leaders agreed on three main things. The first was that they supported Greece remaining in the euro. According to the communiqué:
We agree on the importance of a strong and cohesive eurozone for global stability and recovery, and we affirm our interest in Greece remaining in the eurozone while respecting its commitments. We all have an interest in the success of specific measures to strengthen the resilience of the eurozone and growth in Europe
The second was a commitment to ‘fiscal responsibility’ and the clawing down of public-sector deficits.
We commit to fiscal responsibility and, in this context, we support sound and sustainable fiscal consolidation policies that take into account countries’ evolving economic conditions and underpin confidence and economic recovery.
The third was commitment to boosting economic growth. (Click on chart for a larger image.) On the supply side this would be through measures to stimulate productivity. On the demand side this would be through policies to stimulate investment.
(For a PowerPoint of the chart, click on the following link: Quarterly Growth.)
To raise productivity and growth potential in our economies, we support structural reforms, and investments in education and in modern infrastructure, as appropriate. Investment initiatives can be financed using a range of mechanisms, including leveraging the private sector. Sound financial measures, to which we are committed, should build stronger systems over time while not choking off near-term credit growth. We commit to promote investment to underpin demand, including support for small businesses and public-private partnerships.
But the communiqué was short on details. How will fiscal consolidation be achieved? Does this mean a continuation of austerity measures? And if so, what will be the impact on aggregate demand? Or if fiscal consolidation is slowed down, what will be the impact on financial markets?
If a growth in investment is central to the policy, what will be the precise mechanisms to encourage it? Will they be enough to combat the deflationary effect on demand of the fiscal measures?
And how will productivity increases be achieved? What supply-side measures will be introduced? And will productivity increases be encouraged or discouraged by continuing austerity measures?
Lots of questions – questions raised by the articles below.
Articles
Capitalism at a crossroads Independent (19/5/12)
Barack Obama warns eurozone to focus on jobs and growth The Telegraph (20/5/12)
G8 Summit: World leaders push for Greece to stay in the eurozone The Telegraph, Angela Monaghan (19/5/12)
Obama sees ’emerging consensus’ on crisis Sydney Morning Herald, Ben Feller and Jim Kuhnhenn (20/5/12)
G8 leaders tout economic growth, fiscal responsibility CNN (20/5/12)
G8 focuses on Eurozone Gulf News (20/5/12)
G8 leaders back Greece amid tensions France 24 (20/5/12)
G8 splits over stimulus versus austerity Financial TimesRichard McGregor and Kiran Stacey (19/5/12)
Cameron is consigning the UK to stagnation Financial Times, Martin Wolf (17/5/12)
Time to end ‘Camerkozy’ economics Financial Times, Ed Miliband (18/5/12)
Obama: Eurozone ‘must focus on jobs and growth’ BBC News (20/5/12)
World leaders back Greece, vow to combat financial turmoil Reuters, Jeff Mason and Laura MacInnis (19/5/12)
Germany isolated over euro crisis plan at G8 meeting in Camp David Guardian, Patrick Wintour (19/5/12)
G8 leaders end summit with pledge to keep Greece in eurozone Guardian, Ewen MacAskill (19/5/12)
G8 summit ends with few tangible results Xinhua, Sun Hao (20/5/12)
Final communiqué
Camp David DeclarationG8 (19/5/12)
Questions
- To what extent are economic growth and fiscal consolidation (a) compatible; (b) incompatible objectives? How might a Keynesian and a new classical economist respond to these questions?
- What supply-side measures could be introduced by the EU?
- Why might dangers of protectionism increase in the coming months?
- What would be the impact of a Greek default and exit from the eurozone on other eurozone economies?
- What monetary policy changes could be introduced by the eurozone governments and the ECB in order to ease the sovereign debt crisis of countries such as Grecce, Spain, Portugal, Italy and Ireland?
In the second part of this blog, we look at an interview with the Guardian given by Robert Chote, Chair of the UK’s Office of Budget Responsibility. Like Mervyn King’s, that we looked at in Part 1, Robert Chote’s predictions are also gloomy.
In particular, he argues that if Greece leaves the euro, the effects on the UK economy could be significant, not just in the short term, but in the long term too.
The concern is that you end up with an outcome in the eurozone that creates the same sort of structural difficulties in the financial system and in the economy that we saw in the past recession, and that that has consequences both for hitting economic activity in the economy, but also its underlying potential. And it’s the latter which has particular difficulties for the fiscal position, because it means not just that the economy weakens and then strengthens again – ie, it goes into a hole and comes out – but that you go down and you never quite get back up to where you started. And that has more lingering, long-term consequences for the public finances.
The interview looked not just at the effects of the current crisis in the eurozone on the eurozone, British and world economies, but also at a number of other issues, including: the reliability of forecasts and those of the OBR in particular; relations between the OBR and the Treasury; allowing the OBR to cost opposition policies; the economic effect of cutting the 50p top rate of income tax; the sustainability of public-sector pensions; and tax increases or spending cuts in the long term.
In Part 3 we look at attempts by the G8 countries to find a solution to the mounting crisis.
Articles
Robert Chote interview: ‘I would not say in the past there’s been rigging’ Guardian, Andrew Sparrow (18/5/12)
UK ‘may never fully recover’ if Greece exits euro Guardian, Andrew Sparrow, Helena Smith and Larry Elliott (18/5/12)
British economy may ‘never quite recover’ from a severe Euro collapse The Telegraph, Rowena Mason (18/5/12)
OBR report
Economic and fiscal outlook Office for Budget Responsibility (March 2012)
Questions
- Why is it very difficult to forecast the effects of a Greek withdrawal from the euro?
- Why may Greek withdrawal have an effect on long-term potential output in the UK and the rest of Europe?
- Why are economic forecasts in general so unreliable? Does this mean that we should abandon economic forecasting?
- Why are public finances “likely to come under pressure over the longer term”?
- Why might the cut in the top rate of income tax from 50% to 45% have little impact on economic growth? Distinguish between income and substitution effects of the tax cut.
The International Monetary Fund has just published its six-monthly World Economic Outlook (WEO). The publication assesses the state of the global economy and forecasts economic growth and other indicators over the next few years. So what is this latest edition predicting?
