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10 April 2016

The world doesn’t need more stim­u­lus

Global growth rates are adjusting for China’s inevitable slowdown. But where is the demand gap some observers decry, asks Ludger Schuknecht.

Dr. Ludger Schuknecht, Chief Economist at the German Finance Ministry

Dr. Ludger Schuknecht, Chief Economist at the German Finance Ministry
Ludger Schuknecht, chief economist at the German Finance Ministry

The International Monetary Fund on Tuesday releases its latest economic-growth forecasts. Some observers will use them to support a call to do more for what they perceive to be a flagging global economy.

But economic judgment and advice have a lot to do with expectations. This is especially true when it comes to judging economic prospects. And although commentators rarely argue about the numbers and the broad trend, there is considerable disagreement about whether prospects are gloomy or bright.

It’s worth pointing out that gloom is largely the result of unreasonable expectations about where growth rates can and should be. And to some, gloom can be used to justify an expansionary policy stance.

These days, declining global growth shouldn’t come as a surprise. It reflects in large part an adjustment in Asia to more sustainable growth rates. Meanwhile, advanced economies are holding up well. Global growth is averaging slightly above 3% a year, just as it has been over the past three decades. For the G20 nations, this is called moderate growth. It implies a doubling of global per capita income in little more than a generation. That’s hardly a disappointment.

Among emerging Asia, take the case of China, where growth projections for have been revised downward by more than two percentage points in recent years. For the global economy, this means a negative growth effect of more than half a percentage point from China alone. Growth forecasts for other emerging economies have also been revised down.

Is it so unreasonable, then, for global growth to appear to be slowing as Chinese forecasts fall to 6% a year from 8% or 9%? This deceleration was inevitable, as China shifted its economy to focus more on domestic demand and services. That other emerging economies are slowing down too is also reasonable. After all, most of these countries had strong growth for 15 years. Asian growth of more than 5% a year, as currently projected by the Asian Development Bank, remains a stunningly positive outlook, implying a doubling of per capita gross domestic product in as little as 15 to 20 years.

The challenge for emerging economies now is to maintain high growth rates while continuing the process of playing economic catch-up. This requires structural reform to strengthen productivity and trade up the value chain in production.

Many emerging economies also need to manage high private debt in an environment of increased dollar-exchange and interest rates, low commodity prices and overcapacities. Further challenges include strengthening domestic financial systems and incentives for prudent financing. In such an environment, it is important not to squander any fiscal or monetary leeway, including reserves. These should be used to cushion the restructuring process, not to encourage the accumulation of more debt or wasteful spending.

In the industrialized world, the economic situation likewise gives little cause for gloom. Today the G7 output gap is near its historical average. Unemployment is at or below pre-crisis levels in Germany, Japan, the U.K. and the U.S., which together account for the lion’s share of the industrialized world’s GDP. In Europe, recovery is under way and growth is well above potential. Former crisis countries Spain and Ireland are posting rapid growth and strong declines in unemployment.

There are pockets of underemployed resources, notably in countries that have been lagging in their reform efforts. But where is that global demand gap that some observers decry?

Further structural reform and financial-sector healing is needed, especially in Europe, to boost productivity and sustainable growth. In light of an aging population, even keeping per capita growth at the current 1% or so in advanced economies would require major efforts.

But some observers hold up different expectations about where potential growth should be. And they deduce from this the need for an immediate expansionary boost to macroeconomic policies. They don’t seem to acknowledge the remarkable support already coming from macroeconomic policies.

Monetary policy is super stimulative in advanced economies, low commodity prices further support demand, and the fiscal stance is also neutral if not expansionary on average. The resulting ultralow financing costs for governments are buying time for reforms, although they also have the unfortunate consequence of slowing the reform process by reducing the sense of urgency.

The G20 consensus in Shanghai last month was that enhancing reforms and making our governments and financial sectors more resilient are the best ways to support growth, build confidence and prevent another crisis. Jumping the gun and talking down the global economy to justify more activism now just wouldn’t be productive.

This article first appeared in The Wall Street Journal on 10 April 2016.

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