On the surface, the global economy certainly appears to be on the mend. Our estimates put world GDP growth in the 5-5.5% range in the second half of 2003 — double the average gains of 2001-02 and the strongest run-rate in about 20 years. But this global rebound is unlike any experienced in the past — it has been unusually dependent on policy stimulus. Can this nascent recovery in the world economy wean itself from these life-support measures and make the all-important transition to a self-sustaining upturn?
The classic levers of stabilization policy are fully engaged in the major economies of the world. That’s especially true of monetary policy, where central banks have taken policy rates down to rock-bottom levels -- zero in the case of Japan, 1% in the United States, and 2% in Europe. But it’s also true of fiscal policy, with federal budget deficits of 7% in Japan, 4.5% in the US, and above the once sacrosanct 3% threshold in the major countries of the Eurozone. While this does not represent a record degree of fiscal stimulus -- OECD calculations still find slightly larger collective deficits in the early 1980s and again in the early 1990s -- it is the combination that is so extraordinary. Monetary and fiscal policies are collectively providing a stimulus the likes of which the modern-day global economy has never before seen.
A similar conclusion is evident for China -- the world’s newest growth engine. The expansion of China’s broad money-supply growth ended 2003 at about a 20% annual rate. Moreover, the Chinese government’s long-standing campaign of “proactive” fiscal stimulus remains largely in place; such expansive budgetary policies were an outgrowth of China’s response to the Asian crisis, and the government has not been able to reduce its deficit spending much over the ensuing years. As a result, China’s budget deficit has averaged close to 3% of GDP over the 1999 to 2003 period. Recently, Chinese authorities have moved to tighten monetary policy somewhat -- raising bank reserve requirements from 6% to 7% in September 2003. The early returns from this action are encouraging -- bank-lending growth in the final three months of 2003 ran at one-third the pace in the first nine months of the year. But it would be a stretch to characterize China’s overall policy stance as anything other than stimulative at this point in time. The imperative of vigorous Chinese growth remain an overarching objective of the leadership, and the levers of Chinese policy remain set in accordance with achieving this all-important objective.
Meanwhile, despite this massive global policy stimulus, the world continues to suffer from a striking deficiency in the drivers of internal demand. Nowhere is that more evident than in the United States -- still the dominant engine on the demand side of the global economy. Feeling the full force of its most jobless recovery on record, private wage and salary disbursements are lagging gains of the typical business cycle expansion by some $400 billion (in real terms). This shortfall in the largest portion of US household purchasing power -- which accounts for fully 45% of total US personal income -- has forced the American consumer to lean heavily on more “toxic” sources of spending support such as tax cuts, reduced saving, increased debt, and the extraction of purchasing power from overvalued assets such as homes. With tax cuts an outgrowth of massive fiscal stimulus and leverage-induced wealth effects a critical by-product of monetary stimulus, the policy dependence of America’s recovery is unmistakable. In fact, I would argue that the US has never been more hooked on policy stimulus as the sustenance of economic growth at this stage in a business cycle upturn.
Conventional theories have it, of course, that it’s only a matter of time before the baton of macro support shifts from policy to the internal sources of job creation and income generation. The unusual persistence of America’s jobless recovery draws that key assertion into serious question. Meanwhile, it’s not as if a new source of internally generated growth from elsewhere in the world has rushed in to fill the void. That’s certainly true of Europe, where year-over-year domestic demand growth remains below the 1% threshold -- restrained, in particular, by the private consumption component, which is also expanding at only about a 1% annual rate. But it’s also the case in Japan, where surging growth in the second half of 2003 was boosted by a number of one-off factors -- namely, a burst of home refurbishing outlays, a quirk in the capex deflator, and a China-driven surge in exports; to the extent these factors subside in 2004 and the impacts of a stronger yen start to kick in, Japan’s newfound impetus is likely to wane over the course of this year. Nor can the Chinese be expected to pick up the slack; the combined impacts of monetary tightening and a tax-related slowing of export growth should act to moderate China’s growth impetus. At the same time, the Chinese consumer remains constrained by job and income insecurity, key by-products of the nation’s unrelenting restructuring and its still largely undeveloped safety net.
Ultimately, the issue boils down to sustainability -- namely, whether the global economy can draw any additional sustenance from policy stimulus. For the major countries of the developed world, this is a particularly vexing issue -- especially with the policy stance of central banks at or near the zero nominal interest rate boundary. Leeway on fiscal policy is equally problematic. Japan’s government deficit is in uncharted territory, and by violating the Growth and Stability Pact, Europe’s fiscal profligacy threatens the basic tenets of monetary union. Even in the US, where political support for fiscal prudence has all but vanished, the current-account implications of any further deterioration in federal finances is likely to be an increasingly limiting factor. Nor is the developing world in any better shape. According to IMF estimates, over the past decade, declines in the external component of emerging-market indebtedness have been more than offset by increasing domestic leverage. As a result, the public debt ratio in emerging market economies is currently around 70% of GDP -- not only a record but also now in excess of that evident in the industrial world. (see “Public Debt in Emerging Markets: Is It Too High?” Chapter III in the IMF’s September 2003 World Economic Outlook). In short, concerns over policy sustainability are global in scope.
While currencies are a third lever of macro policy for an individual economy, that’s not the case for the world at large. The zero-sum implications of shifts in such relative prices do more to change the mix of global growth than alter its level. But there may be more to it than that. For example, I have long argued that a weaker dollar is the key to global rebalancing and sustained growth in the world economy. For the US, a weaker dollar should eventually spark a back-up in real interest rates that would ultimately suppress domestic demand and lead to a long overdue recovery in America’s national saving rate. Similarly, a strengthening of the euro and the yen could well exert enough pressure on the European and Japanese economies to spark long overdue reforms and restructuring. However, these effects are arguable, at best, and their impacts tend to be very long-tailed. Over the more immediate time horizon, any economic improvements in one currency bloc could well come at the expense of gains in another.
So what does the global economy do for an encore following the stunning upturn in the second half of 2003? To the extent that policy stimulus is nearing its limits, it boils down to the heavy lifting of internal demand. And here it’s important to make a critical distinction between the two major components of domestic demand: The outlook for the capex piece is certainly more constructive than it is for private consumption. That’s because in this IT-enabled era, product replacement cycles have shortened for those who have made the commitment to such technologies (i.e., the United States); for those who have dragged their heels on a relative basis (i.e., Europe and Japan), the case for an IT catch-up is equally compelling. But the private consumption piece -- a sector that typically accounts for about four to five times the output share of business capital spending -- is the real stumbling block to the global recovery dynamic. This is where the issue of policy traction comes face-to-face with the income leakages of jobless recoveries in the industrial world. To the extent that hiring in high-wage developed economies continues to lag, the sustainability of any impetus to private consumption can be drawn into serious question.
Global policy levers are now fully engaged. The forces of private demand are not. To the extent that job creation in the developed world remains much tougher to come by in an increasingly integrated global economy, the conversion of policy stimulus into self-sustaining private consumption could continue to be impaired. Not only does that impede the standard “multiplier” effects that lie at the heart of enduring recoveries, but it leads to a build-up of ever-greater imbalances that ultimately pose the most serious threats of all. You’d never know that from the recent euphoria in world financial markets. That’s just the problem.
On the surface, the global economy certainly appears to be on the mend. Our estimates put world GDP growth in the 5-5.5% range in the second half of 2003 --double the average gains of 2001-02 and the strongest run-rate in about 20 years. But this global rebound is unlike any experienced in the past — it has been unusually dependent on policy stimulus. Can this nascent recovery in the world economy wean itself from these life-support measures and make the all-important transition to a self-sustaining upturn?
The classic levers of stabilization policy are fully engaged in the major economies of the world. That’s especially true of monetary policy, where central banks have taken policy rates down to rock-bottom levels -- zero in the case of Japan, 1% in the United States, and 2% in Europe. But it’s also true of fiscal policy, with federal budget deficits of 7% in Japan, 4.5% in the US, and above the once sacrosanct 3% threshold in the major countries of the Eurozone. While this does not represent a record degree of fiscal stimulus -- OECD calculations still find slightly larger collective deficits in the early 1980s and again in the early 1990s -- it is the combination that is so extraordinary. Monetary and fiscal policies are collectively providing a stimulus the likes of which the modern-day global economy has never before seen.
A similar conclusion is evident for China -- the world’s newest growth engine. The expansion of China’s broad money-supply growth ended 2003 at about a 20% annual rate. Moreover, the Chinese government’s long-standing campaign of “proactive” fiscal stimulus remains largely in place; such expansive budgetary policies were an outgrowth of China’s response to the Asian crisis, and the government has not been able to reduce its deficit spending much over the ensuing years. As a result, China’s budget deficit has averaged close to 3% of GDP over the 1999 to 2003 period. Recently, Chinese authorities have moved to tighten monetary policy somewhat -- raising bank reserve requirements from 6% to 7% in September 2003. The early returns from this action are encouraging -- bank-lending growth in the final three months of 2003 ran at one-third the pace in the first nine months of the year. But it would be a stretch to characterize China’s overall policy stance as anything other than stimulative at this point in time. The imperative of vigorous Chinese growth remain an overarching objective of the leadership, and the levers of Chinese policy remain set in accordance with achieving this all-important objective.
Meanwhile, despite this massive global policy stimulus, the world continues to suffer from a striking deficiency in the drivers of internal demand. Nowhere is that more evident than in the United States -- still the dominant engine on the demand side of the global economy. Feeling the full force of its most jobless recovery on record, private wage and salary disbursements are lagging gains of the typical business cycle expansion by some $400 billion (in real terms). This shortfall in the largest portion of US household purchasing power -- which accounts for fully 45% of total US personal income -- has forced the American consumer to lean heavily on more “toxic” sources of spending support such as tax cuts, reduced saving, increased debt, and the extraction of purchasing power from overvalued assets such as homes. With tax cuts an outgrowth of massive fiscal stimulus and leverage-induced wealth effects a critical by-product of monetary stimulus, the policy dependence of America’s recovery is unmistakable. In fact, I would argue that the US has never been more hooked on policy stimulus as the sustenance of economic growth at this stage in a business cycle upturn.
Conventional theories have it, of course, that it’s only a matter of time before the baton of macro support shifts from policy to the internal sources of job creation and income generation. The unusual persistence of America’s jobless recovery draws that key assertion into serious question. Meanwhile, it’s not as if a new source of internally generated growth from elsewhere in the world has rushed in to fill the void. That’s certainly true of Europe, where year-over-year domestic demand growth remains below the 1% threshold -- restrained, in particular, by the private consumption component, which is also expanding at only about a 1% annual rate. But it’s also the case in Japan, where surging growth in the second half of 2003 was boosted by a number of one-off factors -- namely, a burst of home refurbishing outlays, a quirk in the capex deflator, and a China-driven surge in exports; to the extent these factors subside in 2004 and the impacts of a stronger yen start to kick in, Japan’s newfound impetus is likely to wane over the course of this year. Nor can the Chinese be expected to pick up the slack; the combined impacts of monetary tightening and a tax-related slowing of export growth should act to moderate China’s growth impetus. At the same time, the Chinese consumer remains constrained by job and income insecurity, key by-products of the nation’s unrelenting restructuring and its still largely undeveloped safety net.
Ultimately, the issue boils down to sustainability -- namely, whether the global economy can draw any additional sustenance from policy stimulus. For the major countries of the developed world, this is a particularly vexing issue -- especially with the policy stance of central banks at or near the zero nominal interest rate boundary. Leeway on fiscal policy is equally problematic. Japan’s government deficit is in uncharted territory, and by violating the Growth and Stability Pact, Europe’s fiscal profligacy threatens the basic tenets of monetary union. Even in the US, where political support for fiscal prudence has all but vanished, the current-account implications of any further deterioration in federal finances is likely to be an increasingly limiting factor. Nor is the developing world in any better shape. According to IMF estimates, over the past decade, declines in the external component of emerging-market indebtedness have been more than offset by increasing domestic leverage. As a result, the public debt ratio in emerging market economies is currently around 70% of GDP -- not only a record but also now in excess of that evident in the industrial world. (see “Public Debt in Emerging Markets: Is It Too High?” Chapter III in the IMF’s September 2003 World Economic Outlook). In short, concerns over policy sustainability are global in scope.
While currencies are a third lever of macro policy for an individual economy, that’s not the case for the world at large. The zero-sum implications of shifts in such relative prices do more to change the mix of global growth than alter its level. But there may be more to it than that. For example, I have long argued that a weaker dollar is the key to global rebalancing and sustained growth in the world economy. For the US, a weaker dollar should eventually spark a back-up in real interest rates that would ultimately suppress domestic demand and lead to a long overdue recovery in America’s national saving rate. Similarly, a strengthening of the euro and the yen could well exert enough pressure on the European and Japanese economies to spark long overdue reforms and restructuring. However, these effects are arguable, at best, and their impacts tend to be very long-tailed. Over the more immediate time horizon, any economic improvements in one currency bloc could well come at the expense of gains in another.
So what does the global economy do for an encore following the stunning upturn in the second half of 2003? To the extent that policy stimulus is nearing its limits, it boils down to the heavy lifting of internal demand. And here it’s important to make a critical distinction between the two major components of domestic demand: The outlook for the capex piece is certainly more constructive than it is for private consumption. That’s because in this IT-enabled era, product replacement cycles have shortened for those who have made the commitment to such technologies (i.e., the United States); for those who have dragged their heels on a relative basis (i.e., Europe and Japan), the case for an IT catch-up is equally compelling. But the private consumption piece -- a sector that typically accounts for about four to five times the output share of business capital spending -- is the real stumbling block to the global recovery dynamic. This is where the issue of policy traction comes face-to-face with the income leakages of jobless recoveries in the industrial world. To the extent that hiring in high-wage developed economies continues to lag, the sustainability of any impetus to private consumption can be drawn into serious question.
Global policy levers are now fully engaged. The forces of private demand are not. To the extent that job creation in the developed world remains much tougher to come by in an increasingly integrated global economy, the conversion of policy stimulus into self-sustaining private consumption could continue to be impaired. Not only does that impede the standard “multiplier” effects that lie at the heart of enduring recoveries, but it leads to a build-up of ever-greater imbalances that ultimately pose the most serious threats of all. You’d never know that from the recent euphoria in world financial markets. That’s just the problem.
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