The world trades down

22 January 2019

By Tim Pemberton

Global growth is slowing. Some emerging economies are already in recession and much of the developed world has slowed markedly, with Japan, Germany, Italy, Switzerland and Sweden contracting in late 2018.

There are now doubts about the US economy, the one big advanced country that has helped lift global growth over the past year. All this is happening amid US-China trade frictions and broader concerns about the Chinese economy.

Although risks are rising, we expect world GDP growth to slow, not collapse. We forecast global growth to ease from 2.9 per cent in 2018 to 2.6 per cent in 2019, then 2.4 per cent in 2020.

Slower export growth hit Europe and Japan in 2018, though the direct impact of the US tariffs on global trade is only just becoming apparent. The China-specific tariffs and associated retaliatory action have so far hurt US exports to China more than Chinese sales to America. China has also been better at diversifying its export growth to more rapidly-growing markets.

We expect world GDP growth to slow, not collapse

Soft landings in the US are rare following an interest-rate tightening cycle. After a decade-long expansion it is much more common to see at least a shallow recession. The US Federal Reserve always hopes it can tighten sufficiently to control inflation and unemployment and then ease quickly enough to prevent an outright recession. But gauging the appropriate degree of tightening is particularly problematic at a time of hefty fiscal stimulus and record-low unemployment.

The falling oil price has eased the inflation outlook and we currently still expect the Fed to raise rates by a quarter of a percentage point in 2019. But as Washington’s fiscal stimulus fades and the impact of past rate rises feeds through, we expect a half-point cut in rates after mid-2020 to prevent the slowdown becoming a contraction. Money markets are no longer confident the Fed can deliver any rise in 2019.

The paramount concern about the possibility of a recession is what options central banks might still have to respond.

Lower rates and quantitative easing (QE) by developed countries’ central banks were the response after 2008. However, central banks – particularly in Japan and the eurozone, with their zero rates – will be much more constrained this time, entering the downturn with already bloated balance sheets.

Attention would have to return to fiscal policy – ideally a global response like the one the G20 countries agreed in 2009. If the global economy finds itself teetering on the edge of recession in the next year or two, developed-world bond markets should not prevent governments from borrowing more. And some revival in investment is needed, particularly in Europe.

Governments should focus on projects that would ease private-sector bottlenecks and encourage business activity. For instance, higher spending on research and development and infrastructure might raise medium-term supply potential by boosting productivity.

But which sectors, in which regions, will be willing or able to take on another increase in debt? The fiscal stimulus and QE after 2008 saw public-sector debt rise as the private sector deleveraged. Next time, the US might not want to borrow more; China may not be able to, now that its large current-account surplus has disappeared; and the eurozone looks unlikely to have the political consensus or the institutions to deliver a big stimulus.

This research was first published on 13 December 2018.



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