International Economic Update
Difficult Times and Bold Responses
March 20, 2009
The global outlook continues to deteriorate. The latest data from industrialized countries point toward further declines in growth. Plummeting trade and capital flight are driving emerging markets towards recession. Policymakers worldwide are employing a myriad of tools to stimulate demand and revive credit markets. World output is expected to fall in 2009, the first time it has done so since World War II.
Real GDP growth in fourth quarter 2008 came in at the lower end of expectations for most advanced countries (Chart 1). The two groups of countries hit the hardest are those that rely heavily on manufacturing exports (Japan, Germany and Mexico) and those that recently experienced housing booms (the U.K., Ireland and Spain). More timely indicators of economic activity suggest a further weakening in first quarter 2009. Industrial output has dropped considerably in recent months, while unemployment rates have started to climb. Housing starts in the euro area, U.K. and Japan have fallen. Survey data on business and consumer confidence (Chart 2) shows how rapidly conditions have been deteriorating in recent months.
Spreads between interbank rates and policy rates have narrowed, and interest rates on new loan originations appear to be falling in Europe. This evidence is deceiving, however, and credit conditions remain tight around the world. Euro-area banks are increasingly relying on the European Central Bank (ECB) for liquidity in place of interbank markets; and although loan-rates may be slipping, the volume of credit being issued has slowed (Chart 3). Survey data suggest this drop can be attributed both to banks tightening credit standards and a decline in demand for credit.
Emerging markets seemed relatively immune to the initial impact of the financial crisis, but they have been hit hard by the subsequent shockwaves. These shockwaves have come in the form of capital flight, foreign lines of credit drying up and declining world trade. Exchange rates have collapsed across many emerging markets (Chart 4), putting countries that try to manage their exchange rates under pressure. Growth suddenly turned negative in fourth quarter 2008 in much of the emerging world (Chart 5). Recent industrial production and consumer confidence data suggest that economic activity has deteriorated further over the past few weeks.
With headline inflation rates falling considerably and core rates declining at a moderate pace, monetary policymakers have been able to lower interest rates aggressively. The ECB and the Bank of England have both recently cut interest rates by 50 basis points to 1.5 percent and 0.5 percent, respectively. Although interest rates are approaching zero, monetary policymakers still have tools to boost liquidity. The Bank of England and the Bank of Canada are outlining plans to implement quantitative easing tools, while the ECB is considering a similar move. The Bank of England's plan includes £75 billion of both private-sector asset purchases and government debt purchases.
Government interventions, though dissimilar, have included many common components. Most countries have raised deposit insurance, guaranteed bank debt and loans, and restricted short selling. Few central banks have begun buying commercial paper, but many have been authorized to purchase mortgage-related securities. The majority of countries have also implemented capital injections into banks.
Most countries have also implemented some form of fiscal stimulus. Stimulus plans vary in size and scope. Almost half of the G-20 countries have cut personal income taxes, while approximately one-third have reduced indirect taxes. Three-quarters of G-20 countries have increased spending on infrastructure.
Fourth quarter growth in 2008 was lower than expected across both the industrialized countries and emerging markets. Employment data, confidence surveys and industrial production figures signal little improvement in early 2009. Governments around the world are implementing a wide array of policy responses aimed at easing credit conditions and stimulating demand. While near-term prospects for much of the global economy remain bleak, aggressive fiscal and monetary policy should help stabilize global economic activity later this year and promote a return to growth in late 2009 or early 2010.
About the Author
Roy is a research assistant in the Research Department at the Federal Reserve Bank of Dallas.