Ever since the crash in 2008, the central banks in the advanced economies have had but one obsession — how to set monetary policy to ensure the maximum growth rate in aggregate demand. Interest rates at the zero lower bound, followed by a massive increase in their balance sheets, was the answer they conjured up.
Now, those central banks contemplating an exit from these policies, primarily the US Federal Reserve and the Bank of England, are turning their attention to the supply side of their economies. When, they are asking, will output reach the ceiling imposed by the supply potential of the economy?
The Bank of England has been in the lead here, with the Monetary Policy Committee recently conducting a special study of the supply side in the UK. Its conclusion was that gross domestic product is now only 0.5 per cent below potential, which implies that tighter monetary policy will soon be needed if GDP growth remains above potential for much longer.
In the US, the Fed has been much less specific than that, but the unemployment rate has now fallen very close to its estimate of the natural rate (5.0-5.2 per cent). Sven Jari Stehn of Goldman Sachs has used the Fed staffers’ supply side models to calculate that their implied estimate of the US output gap may be only 0.6 per cent, not far from the UK figure.
If the UK and US central banks were to act on these calculations, the implication would be that they no longer hold out much hope that they can ever regain the loss in potential output that has occurred in the past decade, relative to previous trends. That would be a massive admission, with an enormous implied sacrifice in future output levels if they are wrong. It would also be very worrying for financial assets, since it would draw the market’s attention to a downgrade in the Fed’s estimation of the long-run path for GDP. Read more
© STR/AFP/Getty Images
China’s economic rebalancing has been the main downside risk to global economic activity in 2014, and will probably remain so for the foreseeable future. The industrial production figures for August were the weakest seen since the 2008-09 recession, and they were followed by a statement from finance minister Lou Jiwei to the effect that there would be no change in economic policy “in response to one indicator”.
This echoed Premier Li Keqiang’s recent speech at the summer Davos meetings, which indicated broad satisfaction with the overall thrust of policy. “Just like an arrow shot, there will be no turning back”, he promised.
The possibility of a clash between a slowing economy and a Chinese administration that appears implacably set on a pre-determined course was not what the markets wanted to hear. Many western investors have long been predicting a hard landing for China, and do not need much persuasion to believe that it is finally at hand. But recent data do not suggest that it is happening yet. Read more
The decline of 0.1 per cent in US real GDP in 2012 Q4 (at a seasonally adjusted annualised rate) is a definite negative surprise for financial market sentiment, which has become very complacent about the ability of the US economy to withstand the fiscal tightening due to hit the economy.
Fortunately, the underlying picture for final domestic demand is reassuring, which is why the markets have taken these figures in their stride. Today’s figures are unlikely to signal a serious downturn.
But the US economy almost never posts a negative quarter in the middle of a robust upswing, so the figures should give us some pause for thought. Furthermore, the weakness of exports, which is more than a one quarter phenomenon, shows that the global economy had become dangerously dependent on the strength of the US consumer towards the end of last year. Read more
The chancellor’s Autumn Statement exactly marks the halfway point in the current UK parliament, and sets a course for the next election which will now be hard to change. When the coalition embarked on its economic strategy in 2010, it was fully expected that there would be a bleak electoral patch in mid-term, but the Treasury believed that the strategy would be seen to be successful by 2015. In point of fact, however, the mid term blues have been worse than predicted, and GDP forecasts for the remainder of the parliament have been sharply downgraded.
Mr Osborne has reacted to these developments by amending his budgetary strategy in two respects. First, he has allowed the fiscal stabilisers to operate in full, so the effects of the GDP downgrades have been reflected in extra public borrowing in 2011/12 and 2012/13. Sensibly, he has not been overly rigid and there has been no attempt stick to his original fiscal path. As a result, there has been almost no tightening in the underlying fiscal stance this year, and the planned tightening for next year is about 1 per cent of GDP, similar to the plans in other major economies.
Second, he has extended the time period over which the fiscal austerity will take effect, so that his formal fiscal objectives will be reached in 2016/17, instead of 2015/16. The fiscal stance will tighten by about 1 per cent of GDP in each of the next 5 years. The same amount of fiscal austerity, spread over a longer period, is the consequence of these changes. Read more
The transfer of power in China from the outgoing regime led by Hu Jintao to the incoming leadership of Xi Jinping has occurred without a hitch. This is a mark of increased political maturity in China.
In fact, the handover has been described by Citigroup economists as the first complete and orderly transition of power in the 91-year history of the Chinese Communist party.
During President Hu’s decade, China’s real GDP per capita rose at 9.9 per cent per annum. China accounted for 24 per cent of the entire growth in the global economy, and Chinese annual consumption of many basic commodities now stands at about half of the world total. Perhaps the most important question in the world economy today is whether China’s economic miracle can continue in the decade of Xi Jinping. The IMF forecasts shown in the graph above suggest that the miracle will persist, but many western economists disagree. Read more
The annual meetings of the IMF and the World Bank take place in Tokyo this week, and as always they provide a good opportunity to take stock of the condition of the global economy, and of economic policy.
There is much less of a crisis atmosphere surrounding this week’s meetings than there was a year ago, largely because the actions of the ECB have succeeded in calming the eurozone storm for the time being.
However, there have been significant downgrades to growth prospects in China and India in the past year, and growth in the major developed economies has been extremely unsatisfactory. Read more
Risk assets rose slightly last week, and global equities are still trading within about 2 per cent of their highs for the year. The resilience of equities was slightly surprising in a week which saw both a disappointing set of US GDP data and a Fed policy statement which was on the hawkish side of expectations. Goldman Sachs’ economists commented that the US economy and financial markets are “moving into a tougher environment”, in which the economy is slowing and the Fed is shifting its policy reaction function in a less stimulative direction.
One reason why risk assets have remained firm recently, is that earnings in the latest company reporting season have once again been beating expectations in the US and the eurozone. According to Jan Loeys at JP Morgan, US corporate earnings per share for 2012 Q1 have come in 8 per cent higher than analysts’ expectations, while the drop in eurozone earnings has been 4 per cent less than feared. Clearly, corporate financial strength has been helping investment sentiment, but that would not persist for very long if the Fed really did change its tune on monetary policy. Read more
American flag draped over the New York Stock Exchange. Getty Images
Such has been the intensity of the market’s focus on events in the eurozone in recent weeks that the performance of the American economy has barely merited any attention. At least, that has been the case in this blog, which usually tries to concentrate on the key events in global macro which are dominating market sentiment at any given time. So I have been looking across the Atlantic to check on what I might have missed.
In sharp contrast to the eurozone, the US economy has been performing better than was generally expected a couple of months ago, but it remains very vulnerable to the fiscal tightening which now seems likely next year, and to a worsening in the eurozone financial shock. This shock has not yet crossed the Atlantic with any force, but might do so before too long. Read more
How much government debt is too much government debt? That question is pertinent in most economies today, but is especially pertinent in the US, where Congress is debating whether to raise the government debt ceiling, and if so on what terms. Unless economists can give sensible advice on the appropriate maximum level for public debt, much of the debate on budgetary policy is based on little more than political bias or, even worse, gut feeling dressed up as expert opinion. Read more
The Bank of England’s latest Inflation Report was certainly a downbeat document. Mervyn King, Bank governor, said there are “difficult times ahead”, because the economy is still undergoing a slow adjustment to the impact of the financial crisis. By reducing its GDP growth forecasts while simultaneously increasing its inflation projections, the Bank has signalled that it believes the UK is now facing a series of supply side problems – and those are always the most difficult for any central bank to handle. Read more
When the first estimate of UK GDP in 2010 Q4 showed a fall of 0.5 per cent, I commented in this blog that this news was “too bad to be true”. The second estimate for Q4 came out this morning and, sure enough, the figures were – worse. Undaunted, I am still strongly of the view that this depressing quarter does not give an accurate reading on the true state of the UK economy at present. Most other information points to a continuation of reasonably healthy growth in recent months, and a strong bounce-back in the official GDP number is still to be expected in Q1. Read more
The UK GDP data for 2010 Q4 were so bad, and they are potentially so important as a signal for other countries which are about to embark on fiscal tightening, that they are worth another look. 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
The batch of new year forecasts for the world economy have been almost uniformly positive this year, at least from economists in the financial markets. Only a few months ago, forecasters were talking of increasing risks of a double dip recession, but the surge in risk assets since the Federal Reserve announced QE2 in the autumn has swept away most of this pessimism. JP Morgan this week said simply that “strong global growth is baked in the cake”. Although nothing in economic forecasting is that certain, there is plenty of evidence in favour of the recent outbreak of optimism.
First, the most reliable and timely indicators of global economic activity have recovered strongly in recent months. Although QE2 may have helped somewhat in this regard, it is much more likely that the pause in the global economy was anyway about to end when the Fed took its expansionary decisions in the early autumn. Read more
David Cameron took a gamble yesterday with his promise that the UK will in future publish official statistics for national well being. Read more
From now on, GDP figures in the UK will be watched with more than usual interest, because Britain is embarking upon the most significant fiscal tightening among the G7 nations. Can the economy withstand it?
Today’s GDP statistics for the third quarter, which show that the economy is growing at an annualised rate of 3.2 per cent, were much stronger than expected, and suggest that the economy is in better shape than many economists had predicted as the government is launching its fiscal retrenchment. However, the composition of the data is somewhat less encouraging than the picture painted by the headline figures. Read more