International Economic Update

Global Growth Gains Traction, but Recovery Is Uneven
April 30, 2010

Since the second half of 2009, the recovery has been more robust and broad based than anticipated, although it remains uneven across regions. Emerging economies are outperforming the rest, while most advanced economies face the medium-term prospect of sluggish growth. Inflationary pressures are still subdued, even though the slack accumulated during the recession is slowly starting to revert. Core inflation remains stable in the advanced economies.

Some downside risks cloud the outlook for a sustained recovery in the advanced economies. These include large amounts of underutilized resources (such as weak labor markets and low capacity utilization rates) and their impact on potential growth, and deteriorating public finances. Emerging economies face the challenge of maintaining strong growth driven by domestic demand while keeping inflation under control.

Recovery Under Way

Signs of broad-based recovery are evident in the expansion of industrial production (Chart 1). In February, Japan posted the strongest rebound, with a 29.8 percent increase from year-ago levels, and the U.S. counted eight consecutive months of industrial production gains. The Global Purchasing Managers' Index (PMI), measured by J.P. Morgan, reached its highest level since July 2007 at 56.7, and the Services Index rose to 56 from 52.7 in February (readings over 50 imply expansion). These data point to improvement across all sectors.

International trade has regained its footing, notably among the emerging economies as they quickly return to solid growth. For the advanced economies, exports have expanded more than imports. However, the U.S. real trade deficit deteriorated in the second half of 2009. Capital goods, including automotives, accounted for most of the U.S. import growth (13.3 percentage points out of the 16.1 percent quarter-over-quarter annualized increase in fourth quarter 2009), signaling a pickup in investment. Nonetheless, trade volumes in the advanced economies are still off from their prerecession levels (Chart 2).

The latest real gross domestic product (GDP) data confirm the uneven global recovery. China's GDP rose 11.9 percent in the first quarter from the previous year, accelerating from 10.7 percent in fourth quarter 2009. India posted 6 percent year-over-year growth in the last quarter of 2009. The U.S. is outstripping most advanced economies at 0.06 percent growth from a year ago, while the euro area stalled at –2.2 percent in fourth quarter 2009.

Medium-Term Outlook

The depth of the recession has resulted in broad declines in employment and, in some instances, increases in discouraged workers leaving the labor force. Labor adjustments have occurred through higher unemployment and fewer hours worked, with significant variations across countries. Hoarding practices or regulatory incentives such as short-time work programs may have lessened the recession's impact on unemployment in some countries. However, these practices may dampen employment growth during the recovery because firms are more likely to boost hours worked than hire anew.

Unemployment rates have still gone up for most of the advanced economies, and structural unemployment (the nonaccelerating inflation rate of unemployment, or NAIRU) is projected to trend upward through 2010 (Chart 3). The level of idle capacity in most of the advanced economies is also high (Chart 4). The evidence of heavily underutilized resources is consistent with the argument that the recession may have had lasting effects on potential growth.

The International Monetary Fund (IMF) and the Organization for Economic Cooperation and Development (OECD) compute potential output from total factor productivity and structural resource utilization. The latter includes estimates of either capital utilization or capital services, the NAIRU, hours worked and other demographic factors.

Table 1 shows that the recession's impact is expected to lower the advanced economies' potential growth below prerecession averages for an extended period. Projected lower potential growth implies that inflationary pressures could reappear even at low growth rates. In contrast, U.S. potential growth has been revised significantly upward from last year's projections—for example, the 2009 projection for 2010 was 0.9 percent, while the latest forecast is 1.2 percent. If these forecasts hold, the U.S. might experience more robust and noninflationary growth than other advanced economies in the medium term.

Table 1
IMF and OECD Projections Reflect Lower Potential Growth
 
1978–87*
1988–97
1998–2007
2008
2009
2010
2011
2012
2015
Advanced economies (a)
3.0
2.9
2.5
 
1.7
 
1.1
 
1.2
 
1.4
 
n.a.
n.a.
     U.S.
3.0
3.0
2.8
 
1.9
 
1.5
 
1.2
 
1.5
 
2.0
2.2
     Euro area (16)
n.a.
2.2
2.0
 
1.4
 
.4
 
.6
 
.9
 
1.0
1.3
     Japan
3.2
2.9
1.0
 
.2
 
–1.4
 
0
 
.9
 
1.6
1.6
Total OECD (b)
3.1
2.7
2.4
 
2.0
 
1.5
 
1.3
 
1.4
 
n.a.
n.a.
     U.S.
3.1
3.1
2.9
 
2.3
 
1.7
 
1.4
 
1.6
 
n.a.
n.a.
     Euro area (13)
n.a.
n.a.
2.0
 
1.7
 
1.2
 
.9
 
1.0
 
n.a.
n.a.
     Japan
4.2
2.6
.9
 
.5
 
.2
 
.5
 
.8
 
n.a.
n.a.
*The average of the International Monetary Fund (IMF) estimates is computed over 1981–87 due to data availability.
NOTES: (a) IMF estimates and projections. The advanced economies are 33 countries, as classified in the IMF's World Economic Outlook, April 2010, and the euro area includes 16 countries. (b) Organization for Economic Cooperation and Development (OECD) estimates and projections. The euro area includes only 13 countries.
SOURCES: IMF, OECD; authors' calculations.


In spite of improving financial conditions, concerns are growing that widening fiscal deficits and mounting public debt could become a drag on future growth. This may shake confidence in governments' ability to shoulder debt without creating inflation and/or avoid a sovereign debt crisis. Governments will need to credibly commit to fiscal consolidation—or face a prolonged period of higher public indebtedness (Chart 5). 

Inflation and Monetary Policy

Headline inflation is up as energy and commodity prices have again picked up with the global recovery. The IMF expects inflation to reach 1.5 percent in the advanced economies and 6.2 percent in the emerging economies this year, both upward revisions from last year's projections. Core inflation remained relatively stable in the advanced economies even at the height of the recession (Chart 6).

Unemployment and capacity utilization rates have begun to stabilize, and the IMF has accordingly updated its output gap projections—a gauge of expected inflationary pressures—to show smaller gaps in the medium term in the advanced economies. The revisions illustrate the uncertainty with which slack is estimated (Chart 7).

Central banks in advanced economies (except for the Reserve Bank of Australia) have kept policy rates unchanged. Instead, they are gradually shrinking their balance sheets by cutting back liquidity provision facilities, indicating their readiness to progressively return to more conventional monetary policy when the conditions are right. The Bank of England ended its £200 billion quantitative easing program on Feb. 17, 2010, and the European Central Bank ended its 12-month long-term refinancing operations on Dec. 16, 2009, and its six-month operations on March 31, 2010. Some emerging economies have begun to tighten policy amid concerns of overheating. The People's Bank of China increased reserve requirements for large commercial banks in January and aims to curb lending this year to cool the economy and avoid a spike in prices.

In sum, the advanced economies are lagging behind the emerging economies in the recovery phase, although growth has strengthened since the second half of 2009. Risks to the recovery outlook include mounting public debt and elevated levels of underutilized resources. Inflationary pressures in the advanced economies are mostly subdued. Most central banks are still keeping monetary policies expansionary, but some have started to unwind the liquidity provision programs set in place at the height of the recession.

—Enrique Martínez-García and Janet Koech

About the Authors

Martínez-García is an economist and Koech is a senior research analyst in the Research Department at the Federal Reserve Bank of Dallas.

 

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