It is Not Then That The Global Economy has Returned to Normal

January 21, 2016

Franziska Ohnsorge PARKIET (Poland), interview by Grzegorz Siemionczyk

Interview with Franziska Ohnsorge, a Lead Economist in the Vice-Presidential unit of the Development Economics and Chief Economist, Development Prospects Group at the World Bank.

The World Bank is forecasting that the global economy will grow by 2.9 percent this year as compared to 2.4 percent in 2015. If those forecasts are fulfilled – and during the recent years, they proved excessively optimistic – then this will be the most successful year in the global economy since 2011.

Contrary to what it might seem, those are not excessively optimistic forecasts. Compared to the previous issue of our report "Global Economic Prospects" (of June last year), we decreased by 0.4 percent points both the estimates of GDP growth in 2015 and the forecast for this year. First, however, the growth rate acceleration by 0.5 percent points that we assume for this year will be, largely, the outcomes of the fact that Brazil and Russia that are combatting recession should shrink slower than during the last year while other countries exporting raw materials would stop slowing down. Briefly, we expect stabilisation of the global market situation rather than clear acceleration of growth.

Global economy continues working at lower revolutions than before the crisis. However, maybe the years preceding that crisis were simply exceptionally good?

GDP growth is lower not only as compared to the years immediately preceding the crisis, but also compared to the entire past quarter of the century. It is not then that the global economy has returned to normal. It is still growing exceptionally slowly. Which is important, this is, to a significant extent, the outcome of slower growth than before in emerging and frontier economies. In the past, as a rule, they experienced slowdowns when mature economies had problems. Today the situation is different because the mature economies, such as the U.S. and Eurozone, although they are growing at a slower pace than their long-term average, their growth, nevertheless, is accelerating. Overall then, this recovery is still fragile, but it is slowly gaining momentum.

There are two basic theories by means of which the weakness of global economy is usually explained. One of them says that it continues combating the heritage of the crisis in the form of the excessive indebtedness of the nations, weak banks, etc. According to the second one, the world is at the stage of long-term (secular) stagnation resulting from an excess of savings relative to the investment demand. Which of them is more convincing to you?

Both of them are partly true. The fact that in both the USA and many emerging economies consumers remain cautious, they save more than before, for example, and this can be considered the legacy of the crisis. Companies also save and are not very confident about investing, and in many countries this also applies to governments. This, obviously, is the result of the excessive indebtedness that characterised the crisis. However, the global economies potential growth rate has also decreased, which is consistent with the secular slowdown theory. In case of the emerging economies, this is the outcome of slowing productivity growth, demographic trends, etc.

The problem is that the low productivity growth rate is a poorly diagnosed phenomenon. Some of the economists claim even that it is just a statistical artefact, i.e. that productivity growth during the times of the Internet escapes measurements. Is it possible that the global market situation is actually better than suggested by the GDP growth rate?

We have not conducted studies on the subject that could provide an answer, but the weakness of the global market situation is evident by many other data, and not only GDP.

Theoretically, the decrease in oil prices should be a strong stimulus for the global economy. This has not happened, however. Why?

Actually, our estimates suggest that decrease in global oil prices by 30 percent should add 0.5 percent point to the global economy growth rate. This time, however, this mechanism did not work. I think that this results to a high extent from the careful attitude of the consumers I have already mentioned. However, there are also other explanations. For example, in the past, the stimulating nature of the decrease in the oil price in many countries resulted largely from the fact that it resulted in the loosening the monetary policy. That was, traditionally, the situation in the USA. This time, however, when oil started getting cheaper, the interest rates in the largest economies were close to zero already. Moreover, the collapse in the oil market was so rapid and deep that the exporting countries were forced to tighten their fiscal policy, and frequently also monetary policy, despite inhibiting the growth of their economies.

In the countries importing oil, however, price decreases induce deflation pressure to which the central banks react by loosening monetary policy. Some of the economists believe that – paradoxically – unprecedentedly loose monetary policy, and particularly mitigating it by unconventional methods, inhibits investments because it raises fears among entrepreneurs and decreases the rates of return on capital.

It is true that investment growth in the world has been very low. We explain it, however, not by fears related to the consequences of actions taken by the central banks, but rather the uncertainty of the economic prospects. We believe that central banks have acted appropriately in loosening monetary policy when the risk of getting inflation expectations “off the anchor” exists. This also applies to the programme of quantitative mitigation of the monetary policy (the so-called QE, i.e. purchase of assets for creating the money – editor) by the European Central Bank. Particularly given that in the Euro zone, core inflation, i.e. excluding food and energy prices, is low.

As we are talking about the Euro zone – how do you evaluate the prospects of that economy? During recent years, it seemed a number of times that the euroland is returning to the growth path and then it stumbled suddenly. Would the revival that has been seen in that region for a number of quarters not prove volatile?

We expect that this year the GDP growth in the Euro zone will accelerate to 1.7 percent from 1.5 percent in the past year. Evidently, then, the recovery is strengthening. However, a deeper slowdown than we expect in the largest emerging economies is a key risk to our scenario. That could hit the mature economies via the trade channel and through consumer and business confidence.

How does the wave of immigrants from the Middle East and Africa influence the European economy?

Initially, it will lead to an increase in fiscal expenditures, but those costs will not be spread evenly. They will be incurred first by the countries in which the immigrants land, i.e. the border like Greece and Italy, and then where they will settle, i.e. Germany. In the latter, their budget situation allows them to cope with these initial costs although some help may have to be given to the countries where they first land, whose budget positions and general capacity may not be as strong. In the longer term, the immigration of young and frequently well-educated people will be positive for the European economy, which has a rapidly ageing society, as long as polices are put in place to support their integration.

You said that slowdown of large emerging economies was the major hazard for the revival in the Euro zone. I understand that you have in mind, first, the risk of the so-called hard landing in China …

The economy of China is moving towards a new balance in which the service sector will be of more importance than the manufacturing sector. The slowdown of growth is one aspect of that process. That, however, is nothing new; that process has continued for a few years now and it seems that it is progressing in line with the authorities’ plan. We expect that this year the Chinese economy will grow by 6.7 percent and that during the following years it will grow at the rate of around 6.5 percent. What we are concerned about then is not the slowdown in a single large emerging economy, but simultaneous slowdowns in a number of them.

However, problems of such countries as Russia, Brazil or the SAR seem to be linked to the growth slowdown in China. All those countries export raw materials, the prices of which decrease as a consequence of, among others, the lower demand of the Middle Kingdom.

From around 2014, the slowdown in the emerging economies resulted, largely, from a coincidence of factors specific to individual countries. For example in case of Russia, the economy is forecast to be in recession this year – its GDP will decrease by 1.7 percent following the decrease by 3.7 percent during 2015 – largely due to declining commodity prices and the result of geopolitical tensions. In the case of Brazil, where the recession continues (GDP will decline by 2.5 percent, compared to 3.5 percent in 2015 – editor) this is partly the outcome of political uncertainty inhibiting investments. Of course, in both countries those problems coincided with the difficult external environment. Decreasing prices of raw materials forces them to tighten fiscal and monetary policies, which is countercyclical. In our opinion, the inhibiting influence of China on the prices of raw materials is also exaggerated. Decreases in the prices of oil, metals and other goods are largely of a supply driven nature.

Does normalisation of the monetary policy in the USA represent a major risk to the emerging economies? Given the increase in the dollar debt of many of them, could the increase of interest rates in the USA and the consequential appreciation of the dollar, as some people claim, lead to the repetition of the Asia crisis of the second half of 1990s?

Our analyses indicate that if, as anticipated, the increase in US interest rates accompanies a strong economic situation in America then it will be favourable to global financial markets and the emerging economies. In the meantime, the Fed has indicated clearly that it would not tighten monetary policy unless it is satisfied with the robustness of USA growth.

Independent of what the consequences of increasing the interest rates by the FED will be in the longer time perspective, it is clear that in the short term this will be the source of increased fluctuations in currency markets. The international organisations such as the IMF or the World Bank traditionally recommended the emerging economies the liquid currency exchange regime. Given that swinging of the currencies, is this recommendation still strong today or can the authorities allow themselves more intervention?

Controlling the currency exchange rate involves certain challenges. Countries that want to do it must either limit the freedom of capital flows or adjust their monetary policy to the policies of the largest central banks, which means losing a degree of independence in that area.