The new year has provided cheer for macroeconomic optimists. This column by Olivier Blanchard, one of the world’s leading economists, argues that important progress has been made in putting the crisis behind us, but that recovery continues to be hampered by the need for fiscal consolidation and a weak financial system.
Optimism is in the air, particularly in financial markets. And some cautious optimism may indeed be justified.
Compared to where we were at the same time last year, acute risks have decreased. The US has avoided the fiscal cliff, and the euro explosion in Europe did not occur. And uncertainty is lower.
But we should be under no illusion. There remain considerable challenges ahead. And the recovery continues to be slow, indeed much too slow.
Put poetically: We may have avoided the cliffs. But we still face high mountains.
A year ago, we were worried about two short-term risks:
We were worried that gridlock might lead to excess fiscal consolidation in the US. And that firewalls in Europe may not be strong enough to prevent a crisis in Spain or Italy.
The agreement reached at the end of 2012 in the US does not solve the fiscal problems, but the extent of fiscal consolidation in 2013 should be roughly appropriate.
In Europe, progress on a number of fronts, from the Outright Monetary Transaction programme put in place by the ECB to buy government bonds on a conditional basis, to the start of a banking union, has convinced financial markets that the firewall was indeed there, and that Europe was committed to the euro.
Still, we have not yet turned the page. The world recovery continues to be hampered by the need for fiscal consolidation – the reduction of government debt and deficits – and by a still-weak financial system.
A brief world tour
The challenges clearly remain highest in the countries of the Eurozone periphery. We forecast that some countries will have another year of recession, with -1.0% growth in Italy, and -1.5% for Spain (WEO 2013).
The adjustment process is at work. Competitiveness is starting to improve, and export-market shares are increasing. Sovereign spreads have decreased. Cross-border imbalances have stabilised, and in some cases started to reverse. Yet, interest rates are still too high, the required fiscal adjustment still large, and uncertainty still very much present, all leading to low demand and low output.
Core Eurozone countries are doing only a bit better. They are forecast to have positive but anaemic growth: 0.6% for Germany, and 0.3% for France. Some of this low growth is due to fiscal consolidation, some to the lingering effects of uncertainty, and from the weakness in the periphery countries.
Some of it may just be due to low confidence: after many years of crisis and the difficulty of building Europe, consumers and firms are waiting for stronger signs of growth to start spending again. But their behaviour in turn delays growth. Financial conditions are improving, however, and the low numbers I have given hide a gradual strengthening over the course of the year.
Japan fell into recession in 2012. Thanks in part to the new measures announced by the government this month, growth should be positive in 2013 at 1.2%. The higher inflation target and the more ambitious goals for monetary policy are both welcome. The fiscal package has led us to increase our growth forecasts in the baseline scenario by about 0.5% for 2013. Given the high level of debt, and in the absence of a medium-term fiscal consolidation plan, it clearly comes with higher risks of a fiscal crisis.
The US is in better shape than Europe or Japan. The main issue remains the need for a clear medium-term fiscal consolidation plan. But, even in the absence of such a plan, fiscal consolidation is likely to proceed at a reasonable pace in 2013.
And the rest of the economy shows signs of improving health. Housing investment is on the rise. Wealth-to-income ratios have returned to historical levels, suggesting stronger consumption in the future. Even fixed investment, which has been weak, shows some signs of strengthening. While our forecast for growth in 2013 is only 2%, the number hides a gradual strengthening over the course of the year.
Finally, we forecast that both emerging market and developing economies will sustain strong growth, although not at the high rates some of them experienced before the global crisis. Growth forecasts for the group as a whole are 5.5% for 2013, up from 5.1% in 2012. More specifically, we forecast China to grow at 8.2% in 2013, India at 5.9%, and Brazil at 3.5%. Weak investment in India and in Brazil is a source of concern. But, in general, most countries have been able to offset slower external demand with higher internal demand, and to handle the volatility of capital flows.
Overall, these developments lead us to forecast 3.5% world growth for 2013, compared to 3.2% in 2012. Better, but not great. And not enough to make a significant dent in the unemployment rate, which in our forecasts for advanced countries remains at roughly 8%.
Our advice on policy therefore remains largely the same:
Financial market optimism should not lead to policy complacency. Now that Europe has laid out clearer plans, implementation remains key for the Eurozone. Japan and the US still very much need medium term fiscal consolidation plans. And financial reform still has a long way to go. With progress on these fronts, cautious optimism may indeed be justified.