By John Muellbauer

Fed minutes released on October 7 disclosed that as recently as Sept 16, Fed officials thought risks to growth and inflation were roughly equally balanced. And Federal Reserve Chairman Ben Bernanke acknowledged on the same day that though the inflation outlook had improved somewhat, it remained uncertain. The market may have taken these views as representative of central banks round the world, particularly given the ECB decision of October 2 not to reduce rates. Following these releases, the Dow Jones index fell by about 6.5 percent as the market thought the internationally co-ordinated interest rate cut it had been expecting had become less likely. This and the knock-on effects on world markets then helped to force central banks to make the cut the market had expected, but on October 8.

Central banks’ caution about inflation risks is understandable given the experiences of 2008. Forecasting inflation is notoriously difficult. There have been big structural shifts in the world economy such as trade and financial globalisation and in individual economies, such as the decline in trade union power. Monetary policy itself has shifted to a far greater focus on inflation. Energy and food price shocks can be large and very hard to predict. Indeed, the speed of price changes tends to increase with big shocks. Most forecasting models used by central banks therefore put a large weight on recent inflation. This tracks inflation quite well except at turning points because the models miss key underlying influences.

Continue reading "US price deflation on the way"

By Lawrence Summers

With two wars still continuing and violence in Georgia dominating the foreign policy debate; and with the financial crisis and economic insecurity for families dominating the domestic debate, US international economic policy is receiving less attention in this presidential election year than usual. The limited attention it has received has focused on concerns about specific trade agreements, not broader questions of international strategy. That is unfortunate. The next administration faces the prospect of having to make the most consequential international economic policy choices in a generation at a time when the confidence of governments in free markets is being increasingly questioned.

The current distribution of regional economic power is unlike anything that was predicted even a decade ago. The rise of the developing world, its growing share in global output and far greater share of global growth, is perhaps a quantitative but not a qualitative surprise. The qualitative surprise is this: with almost all the industrial world in or near recession, much of the momentum in the global economy is coming from countries with authoritarian governments that are pursuing economic strategies directed towards wealth accumulation and building up geopolitical strength rather than improving living standards for their populations. China, where household consumption has now fallen below 40 per cent of its gross domestic product – which must be some kind of peacetime record – is the most extreme example. Similar tendencies, however, can be seen in other parts of Asia, Russia and other oil exporting countries.

Even before the slowdown in the industrial world, a striking feature of the global economy was the substantial net flow of capital from the emerging periphery to the industrial centre. Rising oil prices have geopolitical as well as economic consequences. The run-up in oil prices over the past year has generated more than $10bn (€6.8bn, £5.4bn) a week in extra revenues for Opec members. Asian export powers and oil exporters have enjoyed a vast accumulation of wealth, adding about $1,000bn a year in assets.

These shifts have affected almost every global economic issue. The pressure created by the investment of these surpluses was one of the big factors driving the excesses that preceded our financial problems. Concern about the flow of imports from countries that have pursued a strategy of export-led growth is a big reason for the protectionist backlash now being seen in the industrialised world. It is now recognised that meaningful efforts to address climate change require a framework that induces China and other emerging markets to co-operate.

It has become a cliché to suggest that the world’s institutional approaches to economic co-operation need overhauling to take into account the rising economic clout of emerging markets and the decline in dominance of the group of seven leading industrialised nations (G7). This is correct. The steps taken so far – the initiation of the G-20 during the 1990s and the adjustments of voting shares in international financial institutions – are valuable if insufficient. Continue reading "The global consensus on trade is unravelling"

By Jagdish Bhagwati

In the 1980s, Japan was feared in the US to be a lethal combination of Superman and the evil genius Lex Luthor in a classic case of what I have called the Diminished Giant Syndrome.

Members of Congress famously smashed a Toshiba radio cassette recorder on the steps of Capitol Hill in protest in 1987. Great Britain at the turn of the 19th century had been marked by similar diffidence, despair and recrimination when Germany and the US were emerging on the world scene. There, Sir Howard Vincent entered parliament festooned with mops, pails and brushes marked “Made in Germany”.

US hegemony survived the exaggerated threat from Japan. But the US is now once again a fearful giant. Many Americans see trade as a peril rather than an opportunity. This has turned the US from what the economist Charles Kindleberger famously called an “altruistic” hegemon into a “selfish” hegemon.

The remainder of this article can be read here. Debate from our panel of economists appears below.

by Willem Buiter

From a cyclical perspective, things look bad for Europe, the US and most of the global economy. My contribution to summer cheer is to note that longer-term local and global economic prospects are likely to be worse than expected. So welcome to boom and bust. Welcome to subdued long-term growth prospects.

The ancient Greeks knew hubris to be one sin the gods will punish. When Gordon Brown, the British prime minister, announced “the end of boom and bust”, Jove must have checked his thunderbolts. Capitalist market econ­omies are inherently cyclical. The private credit system is intrinsically prone to alternating bouts of irrational euphoria and unwarranted depression. Busts play an essential role. They clean up the mess created during the boom by inflated expectations, overoptimistic plans and unrealistic ventures. These become embodied in unsustainable household debt, productive capacity with no foreseeable use, excessive corporate and financial sector leverage and enterprises whose only asset is hope. The correction is painful, even brutal: unemployment rises, as do defaults, repossessions and bank­ruptcies. We entered such a cathartic phase around the turn of the year in both the US and the UK. Continental Europe is not far behind.

The remainder of this column can be read here . Debate from our panel of economists appears below.

By Fred Bergsten

The global economy has clearly decoupled from the US and world growth remains close to 4 per cent in spite of the absence of any increases in domestic US demand. Continued expansion abroad, especially in the emerging market economies, has in fact cushioned the slowdown and so far prevented recession in the US. Hence we are also experiencing the first episode in history of reverse coupling, in which the rest of the world pulls the US forward rather than the opposite.

The most striking feature of the current global economic situation is that the US is the only major country that is seriously contemplating recession and that has adopted aggressive expansionary policies to combat that risk. Most other countries are more worried about inflation than slower growth. Many are experiencing reduced growth, to be sure, but part of their slowing is a natural cyclical reaction to four years of near-record global expansion, at more than 4½ per cent from 2004 to 2007, and the need to focus on price stability. The additional losses because of the housing and credit crises in the US amount only to a couple of 10ths of 1 per cent in most areas, including Europe and Japan. It will reach a full percentage point or more only in the fastest growers such as China, where expansion will remain near 10 per cent. Many of these cuts are in fact welcome as their central banks are tightening monetary policy rather than easing it.

Global growth is thus still likely to approach 4 per cent in both 2008 and 2009 in spite of the sharp slowdown in its largest single economy. The emerging market economies, which now account for half of world output calculated at purchasing power parity exchange rates by the International Monetary Fund, are still expanding at 6-7 per cent. Even the nearest neighbours of the US – Canada and Mexico – are nowhere near recession and have altered their policies much less forcefully. In spite of the international transmission of substantial financial as well as real economic shocks from the US, the traditional relationship where “the world catches cold when the US sneezes” no longer holds.

The second striking feature is the reverse coupling of the global economy. Over the past two quarters, the US has recorded positive growth at an annual rate of 0.8 per cent (in spite of the pronouncements of many observers that recession had already set in). Its “net exports of goods and services”, the gross domestic product equivalent of the current account balance, have strengthened at an annual rate of almost 1 per cent of GDP during that period. Hence the totality of recent US expansion has been provided by the strengthening of its trade balance. Domestic demand has been falling but the US has been saved from recession by the rest of the world.

The improved US trade performance of the past two years is due partly to the substantial, if lagged, restoration of the country’s price competitiveness as the dollar declined by a trade-weighted average of 25-30 per cent since early 2002, reversing most of its excessive run-up during the previous seven years that produced unsustainable current account deficits exceeding 6 per cent of GDP. Equally important, however, is the continued robust growth of the world economy. Every percentage point by which the rest of the world expands domestic demand faster than internal growth in the US produces gains of about $50bn (€32bn, £25bn) for the US external balance. Weighted by US exports, foreign growth exceeded US growth by about 2 percentage points in 2007 and will do so by an average of about 1.5 points this year and next as decoupling persists. Taken together, these currency and comparative growth factors have already improved the real US trade balance, and hence GDP, by almost $150bn since 2006, with gains of another $150bn or so likely through 2009. (The nominal US trade and current account deficits will not improve as much because of the sharp rise in the price of oil imports.)

The Organisation for Economic Co-operation and Development’s new Economic Outlook projects that more than 80 per cent of all US growth in 2008-09 will derive from continued strengthening of its external position. Exports have been climbing at an annual rate of about 8 per cent, at least six times as fast as imports. Unless domestic demand takes an unexpected further fall in the quarters ahead, reverse coupling of the global economy will thus have prevented the US recession that was so widely predicted and feared. Presidential candidates and members of Congress who believe that the US is losing from globalisation should take note of this export-led growth and its creation of excellent new jobs, and recognise the folly of backing away from international trade at a time when it is providing critical gains for their country.

These international macroeconomic developments also provide another telling indication of the shifts in global economic power. As noted, the emerging market economies make up about half the world economy, so their growth of 6-7 per cent assures reasonably strong world output increases even if there were no expansion at all in the rich countries. China alone accounts for 10 per cent of the global total, so its annual expansion of 10 per cent generates a full percentage point of world growth all by itself. The steadily rising diversification of global economic leadership is paying huge dividends to all its participants, most dramatically during this episode to the US as export-led growth saves it from at least the worst ravages of its housing bubble and associated policy errors.

The writer is director of the Peterson Institute for International Economics

By Martin Wolf

Is the spread of prosperity in the interests of citizens of today’s high-income countries? Is globalisation of their economies in their interest?

These distinct questions are raised in my mind by two important columns from Lawrence Summers (“America needs to make a new case for trade” on April 27 and “A strategy to promote healthy globalisation” on May 4). In these, Mr Summers argues that the international economic policies of the US need to be coupled more closely to the interests of its workers. Many Europeans will concur.

This is not to argue that the interests of citizens of high-income countries are more important than those of others. On the contrary, the view that increases in incomes of the poor offset equivalent losses for the rich is morally compelling. But politics is national. Unless or until a global political community emerges, politics will respond only to perceptions of national interest.

The remainder of this column can be read here. Debate from our panel of economists appears below.

Read the debate - comments from, amongst others: Adrian Wood, Kevin H. O’Rourke and Robert Wolfe.

By Lawrence Summers

While the financial crisis dominates current discussion on the US economy, questions regarding America’s future approach to globalisation are looming increasingly large.

Since the end of the second world war, American economic policy has supported an integrated global economy, stimulating development in poor countries, particularly in Asia, at unprecedented rates. Yet America’s commitment to internationalist economic policy is ever more in doubt. Even before the significant increases in unemployment likely in the months ahead, the indicators are all disturbing. Presidential candidates attack the North American Free Trade Agreement. The Colombian free trade agreement languishes. There are increasing attacks on foreign investment in the US, not to mention growing support for restrictive immigration policies.

To all of this the conventional wisdom has a well developed response, with four standard elements. First, the sceptic regarding trade deals or other internationalist policies is educated around the many benefits of trade, not just for exporters but also for consumers and the economy more generally. Continue reading "America needs to make a new case for trade"

By Martin Wolf

In the summer of 1972, as a “young professional” at the World Bank, I went on a mission to South Korea. It was my first experience of something extraordinary: a country that was developing at a breathtaking rate. The country had already enjoyed a decade of economic growth at close to 10 per cent a year. It continued to grow at close to that rate for another quarter of a century.

What struck me about Korea was the determination of its policy-makers to sustain rapid industrialisation. I saw the construction from scratch of the vast Hyundai shipyard at Ulsan that was soon to join the first rank of ship-builders. That bet itself demonstrated something even more remarkable: Koreans’ belief in their country’s ability to achieve global competitiveness.

For the Koreans, exports were both a tool of development and a test of its success. How different this was from east Africa and India, on which I was to work for the following five years. India was almost as sealed from the world economy as it was possible to be. Its annual growth in income per head had fallen in the 1970s to about 1 per cent a year, while industrial productivity seemed to be declining, despite its desperately low level.

The contrast between South Korea’s success and India’s failure was striking. Both used protection and other tools of industrial policy. Yet the orientation of India’s policies was inward-looking and anti-competitive, while that of South Korea was the opposite. In the literature on development and trade, the Korean strategy came to be called “export promotion”, because its economy did not have an overall bias towards the home market.

The contrast between South Korea and India raised the biggest questions in economics: why have some countries succeeded with development and others failed? Why has Korea jumped from poverty to prosperity in a lifetime? Why did India do badly then, but much better recently?

The broad question is the one Erik Reinert states in his title: How Rich Countries Got Rich… and Why Poor Countries Stay Poor. Reinert is a Norwegian professor who now teaches at Tallinn, Estonia. Ha-Joon Chang, a well-known Korean development economist, teaches at Cambridge. But both give strikingly similar answers to this question.

The remainder of this book review can be read here (FT.com subscription required). Discussion from our guest economists is free.