Sustaining a Global Recovery
| Author | Olivier Blanchard |
| Position | Economic Counsellor and Director of the IMF’s Research Department |
| Pages | 8-12 |
Page 8
The recovery has started. Sustaining it will require delicate rebalancing acts, both within and across countries
IN normal recessions, however disruptive they are to businesses and jobs, things turn around predictably. The current global recession is far from normal. Usually, to fight a recession, the central bank lowers interest rates, which results in increased demand and output. People resume buying durable goods such as appliances and cars. Firms start delayed investment projects. Often, an exchange rate depreciation gives a boost to exports by making them cheaper. The lower-than-normal growth during the recession gives way to higher-than-normal growth for some time, until the economy has returned to its normal growth path.
But the world is not in a run-of-the-mill recession. The turnaround will not be simple. The crisis has left deep scars, which will affect both supply and demand for many years to come.
Some parts of the economic system have broken. Some firms went bankrupt that would not have in a normal recession. In advanced countries, the financial systems are partly dysfunctional, and will take a long time to find their new shape. Meanwhile, financial intermediation—and, by implication, the process of reallocation of resources that is central to growth—will bePage 9 impaired. In emerging market countries, capital inflows, which decreased dramatically during the crisis, may not fully come back in the next few years. Changes in the composition of world demand, as consumption shifts from advanced to emerging economies, may require changes in the structure of production. In nearly all countries, the costs of the crisis have added to the fiscal burden, and higher taxation is inevitable.
All this means that we may not go back to the old growth path, that potential output may be lower than it was before the crisis.
How much has potential output decreased? It is difficult to tell: we do not see potential output, only actual output. The historical evidence is worrisome, however. The IMF’s forthcoming World Economic Outlook presents evidence from 88 banking crises over the past four decades in a wide range of countries. While there is large variation across countries, the conclusion is that, on average, output does not go back to its old trend path, but remains permanently below it.
The possible good news is that the trend itself appears to be unaffected: on average, crises permanently decrease the level of output, but not its growth rate. So, if past is prologue, the world economy likely will return to its past growth rate. But, especially in advanced countries, the period of above-average growth, characteristic of normal recoveries, may be short-lived or nonexistent.
Just achieving “normal” growth, however, may be hard because of demand problems. The forecasts now predict that growth will be positive in most countries, including advanced countries, for the next few quarters.
Page 10
But there are two caveats to this news:
• Growth will not be quite strong enough to reduce unemployment, which is not expected to crest until some time next year.
• These positive growth forecasts are largely predicated on a combination of a fiscal stimulus and inventory rebuilding by firms, rather than on strong private consumption and fixed investment spending. Sooner or later, the fiscal stimulus will have to be phased out. And inventory adjustment will also naturally come to an end.
“Two rebalancing acts will have to come into play. First, rebalancing from public to private spending. Second, rebalancing aggregate demand across countries.”
The question, then, is what will sustain the recovery.
Two rebalancing acts will have to come into play. First, rebalancing from public to private spending. Second, rebalancing aggregate demand across countries, with a shift from domestic to foreign demand in the United States and a reverse shift from foreign to domestic demand in the rest of the world, particularly in Asia.
The fiscal response to the crisis was to increase government spending, lower taxes, and accept much larger fiscal deficits. Given the collapse of private demand, and the inability to reduce interest rates below zero, governments clearly chose the right response. But large deficits lead to rapid increases in debt, and, because debt levels were already high in many countries, such increases cannot go on for long. As large deficits continue, debt sustainability comes...
To continue reading
Request your trial