Global economy

The Fed decision was fairly close to what was anticipated in this earlier blog – all “twist” and no “shout”. However, on balance, the statement was slightly more dovish than I expected. Concerns about downside risks to economic activity were at least as great as in last month’s FOMC statement, with new downside risks from financial strains being specifically mentioned, and this has swayed the majority of the committee to introduce a slightly more aggressive operation “twist” than expected. Inflation concerns, while marginally greater than in the August FOMC statement, are clearly insufficient to impress the committee, which remains biased towards further easing even after today’s announcement.

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Mervyn King

Mervyn King. Image by Getty.

A few weeks ago, the big central banks were calmly embarking on their “exit” strategies from unconventional monetary accommodation. Then the global economy slowed but for a while inflation remained too high for the Fed or the ECB to consider further easing. Their hands were tied until inflation peaked. Recognising this, markets collapsed. But now that there are some tentative signs of inflation subsiding, the central banks are rediscovering their ammunition stores.

There are basically three types of action that they are considering. In order of orthodoxy, and stealing some of Mervyn King’s terminology, here is a taxonomy of possible measures:

1. Conventional liquidity injections

This is safe territory for the central banks, and they are willing to act swiftly and decisively if necessary. Yesterday’s injections of dollar liquidity into the European financial system are a case in point. Some European banks, especially those in France, were finding it very difficult to raise dollar financing, which they needed in order to pay down earlier dollar borrowings, and to make loans to customers in dollars. The resulting strains in the money markets were undermining confidence in the ability of these banks to remain liquid, and markets were increasingly unwilling to accept their credit. This presented a classic case for the ECB to inject liquidity, using conventional currency swap arrangements to raise dollars from the Fed. Although the ECB will incur a minimal amount of currency risk in the process, and will also incur some credit risk (which will be collateralised), this is very much business as usual for any central bank, as it was in 2008. Read more

A couple of months ago, financial markets realised that the developed economies were slowing sharply, while the policy response from central banks and finance ministries was slow, or confused, or in some cases, like the debt ceiling debacle in Washington, directly damaging. Since then, some policy makers have woken up and smelled the coffee. There have been significant policy shifts in the US, and at the ECB. But there has been no progress whatsoever in the eurozone sovereign debt crisis. Last week, that became by far the most urgent problem facing the global economy. Read more

The global economy, at least in the developed markets, seems poised on the brink of a renewed recession. The growth in real GDP, at an annualised rate, has dropped to around 1 per cent or less in both the US and Europe, and it seems unlikely that growth can continue to hover at this low level indefinitely. Either unemployment will start to rise, in which case recessionary dynamics will take hold, or growth will rebound towards its 2-2.5 per cent long-term trend, and the world will have experienced a narrow squeak.

Which is it to be? I do not claim to know the answer, but I can suggest a few key indicators to watch. In August, these indicators suggest that growth has stabilised at a very low level, rather than nosediving towards imminent recession. Read more

The outbreak of pessimism about the global economic outlook, which seems easy to justify in the case of the developed economies, has now begun to spread to the emerging economies as well. For example, John Plender and Michael Pettis have recently warned that “miracle” rates of growth in the emerging world, notably in China and the rest of Asia, cannot be expected to compensate for failing growth in the US and Europe. These warnings require us to ask some deeper questions about the longevity of the Asian growth miracle. Read more

Update: Read Gavyn’s response to your comments.

As recently as six months ago, mainstream economic forecasters were expecting real GDP growth to be comfortably above trend in 2011, and surveys of business activity were hitting new peaks. Of course, everyone knew that the underlying condition of the western economies was still very weak, but that did not seem to be sufficient to prevent a continuing normalisation of economic activity, with GDP returning slowly towards pre-recession trends.

We now know that these expectations were extremely complacent. Real GDP growth in the US has slumped to around 1 per cent annualised in the first half of the year, and continental Europe has performed no better in Q2. Forecasters like Goldman Sachs and JP Morgan now estimate that the probability of renewed recession in the US is around one third. So what has gone wrong? Read more

S&P has received some deserved criticism for the timing and nature of its decision to downgrade the long-term sovereign credit rating of the US on Friday. (See for example these excellent critiques by Clive Crook and Paul Krugman.)

Although S&P’s strictures on the path for US debt and the dysfunctional nature of Washington’s recent political games seem valid, what can the ratings agencies actually tell us about the creditworthiness of the US that we do not already know? Very little. And why did they pick the most volatile day in financial markets since the Lehman crisis to deliver their opinions on a debt problem which, by their own reckoning, will play out over at least a decade? Read more

Global financial market confidence has collapsed, and visions of the 1930s are flooding back. Recession probability models are flashing red: some suggesting there is now more than a 50 per cent probability of America entering recession before the end of the year. The world’s advanced economies now need an unlikely combination of luck and wise policy to avoid a double dip.

With the global economy uneasily poised between growth and stagnation, there is more than usual interest in the twists and turns of monthly activity data at present. In the next two or three months, we should discover whether the slowdown recorded in the first half of the year was just a temporary phase, triggered by the natural disaster in Japan and the passing impact of higher oil prices, or whether the debt burden in the developed economies is taking a more serious toll on growth prospects.

Most macro-economic forecasters continue to take the more optimistic view, and this is probably still justified. But doubts are creeping in with every month of weak data, and the early read on July from the data published last week has once again been worrying. Read more

The FT led its front page on Monday with a startling headline: “Economic growth must slow, warns BIS“. That’s right, economic growth must slow. As Martin Wolf cogently argues in the FT today, simultaneous deleveraging by private and public sectors, encouraged by all wings of macro policy, could result in a prolonged slump in global demand. Yet the BIS is not alone in its thinking. More and more policymakers seem to be gravitating towards similar conclusions. Read more

The Fed announced today that the US economic situation is far from satisfactory, but that there is nothing much that it can (or will) do about it. Real GDP growth is, by its own admission, lower than the FOMC expected in April, and unemployment has been higher than anticipated. However, its concerns about inflation have risen and, significantly, it has dropped the previous assertion that “measures of underlying inflation are still subdued”.  Chairman Bernanke believes that part of the recent slowdown is temporary, but admits that he is not fully confident that he understands the underlying causes. The FOMC is becalmed, and perhaps slightly bemused. Read more

The data on global economic activity published last week have raised doubts about the strength of the world recovery at the beginning of the second quarter, and there have been some moderate downward revisions to GDP growth forecasts in recent days.  Read more

The newly published IMF World Economic Outlook (WEO) for April 2011 is a particularly excellent document, even by the exalted standards of that publication. Since the credit crunch, the IMF has been given increased responsibilities for monitoring the world economy and for cajoling policy makers in the right direction, especially on issues which spill over from one economy to another. And they have improved the depth of their analysis to meet this task.  Read more

Normally, I write a summary of the week’s major economic events on a Sunday morning. This week I am going to leave the heart-rending events in Japan to be covered by the news teams, and instead focus on two other developments which have important ramifications for the global economy – the slowdown in China, which is becoming increasingly accepted by a previously sceptical economics profession; and the moderately promising deal on sovereign debt which was announced by EU leaders in the early hours of Saturday morning. Read more

China’s GDP growth made news this week because, on the official figures, China overtook Japan to become the second largest economy in the world in 2010. But actually, on a different way of calculating the data, this was very old news. Using purchasing power parity, China not only overtook Japan way back in 2001, but it is also quite close to overtaking the US as the biggest economy in the world – if, indeed, it has not done so already.

GDP statistics measure the amount of value added or income in the economy, measured in domestic currencies, over a given period of time. But it is more difficult to compare the GDP in one economy (China) with that in another economy (Japan), because we need to use an exchange rate which translates yuan into yen or vice versa. This is not as straightforward as it may seem. Read more

This week, the dramatic events in Egypt failed to unsettle the global financial markets. Not only do investors believe that Egypt itself is not critical for global oil prices, they also seem to believe that there will be relatively little contagion to the more important oil producing states elsewhere in the Middle East. Read more

The UK GDP figures for Q4 2010 have been eagerly awaited far beyond Britain’s shores, because the country is currently being seen as a laboratory experiment in what might happen when the rest of the world tightens fiscal policy.  Read more

In a fairly quiet week in global macro, inflation fears remained at the centre of investors’ concerns as data suggested that the UK and China are both struggling to contain price pressures. Rising inflation in the emerging world is fast becoming a headache for the global economy. The eurozone seemed to make some progress on the sovereign debt crisis. And global activity data remained encouraging. Next week, the Fed meets, and US real GDP figures for 2010 Q4 should look pretty good. Read more

China’s economic data for December, released on Thursday, clearly suggest that the authorities have not yet succeeded in slowing the economy enough to bring inflation pressures under control. Read more

From the standpoint of a global macro economist, this is my nomination for the most important graph of the year. (See the end of this blog if you wish to suggest alternatives.) It explains why the world’s largest economy, the US, has defied the pessimists by mounting a decent recovery in 2010. Read more