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Globalization & Monetary Policy Institute
International Economic Update

Global Growth Still Tepid on Back of Euro-Area Recession

December 17, 2012 · Update in PDF PDF

Global economic activity has slumped in recent months, with the latest economic indicators suggesting this weakness may continue in the near term. Waning growth in emerging economies after a strong recovery in 2009 and tempered growth in advanced economies due to uncertainty have led to weak external demand for U.S. exports. The euro-area sovereign debt crisis continues to be the most pressing risk to the global economy, with Greece and Spain set to receive another round of funds.

Global Economic Output Remains Soft

Industrial production (IP) data indicate that output in the global economy has dipped recently. In September, Japan’s IP experienced the largest month-over-month decrease since 2009, except for during the tsunami in 2011, but saw a slight rebound in October (Chart 1A). The euro area also saw its biggest month-over-month decline in IP since 2009 in September and slid further in October. IP in the U.K. fell in both September and October, while the U.S. saw another dip in October after an uptick in September.

Output is also slowing down or remaining flat in many emerging economies (Chart 1B). After edging down in September, IP increased in Brazil, Russia and India in October. The latest industrial production data indicate that China’s economic activity may have bottomed out in the third quarter of 2012. In August, China posted its lowest figures for year-over-year industrial production growth (8.9 percent) since the global financial crisis. However, October year-over-year IP growth was 9.6 percent, and November IP growth was 10.2 percent, suggesting that China may be on an upswing.

The most recent Purchasing Managers Index (PMI) data reveal a volatile global economic expansion (Chart 2). Weak October numbers for the global PMIs were supplanted by stronger growth in the service sector (54.9) and the overall composite index (53.7) in November. Global manufacturing PMI increased in October and November but remains barely in contractionary territory at 49.7.

The PMI indexes in a sampling of major economies show a disparity between manufacturing activities in advanced and emerging economies. China and Brazil returned to expansionary territory in October and increased again in November, while Japan, the U.K. and the euro area are all below the 50 threshold.

The increase in the recent PMI data may be a sign of stabilization in emerging economies, yet emerging countries are still reporting weak real GDP growth (Chart 3). Real GDP growth in emerging economies has been declining since 2010. In the third quarter, China posted year-over-year GDP growth of 7.5 percent, and Brazil reported a slight increase of 1 percent year-over-year GDP growth.

Since 2009, strong demand from emerging economies helped buoy U.S. export growth, but the weakness in both advanced and emerging economies is reflected in flagging external demand for U.S. exports in 2012 (Chart 4A, B). U.S. exports to China, Mexico, Canada and the euro area fell below their 2009–11 trend line in 2012, and it appears that exports may continue below the trend in coming months.

Monetary Policy and Inflation Mostly Unchanged

Inflation is not much of a concern in advanced economies right now, eclipsed by the expectation of weak global economic growth (Chart 5A). November CPI inflation was down to 2.2 percent in the euro area. In October, both the U.S. and the U.K. saw slight increases, while Japan’s CPI inflation decreased to –0.4 percent.

Inflation rates in emerging economies are higher than in advanced economies but are still relatively moderate (Chart 5B). Brazil’s inflation increased slightly in October, while China’s CPI inflation lowered to 1.7 percent. Meanwhile, inflation stayed flat in India and Russia in October.

Partly due to these comfortable levels of inflation, monetary policy changes appear to be on hold in both major advanced and emerging economies. At its monthly meeting on Dec. 6, the European Central Bank (ECB) cut its 2013 growth and inflation forecasts for the euro area, but kept its 0.75 percent policy rate unchanged. In recent meetings, other central banks have largely maintained their policy rates and have suggested that they will be kept unchanged for a while.

Euro-Area Sovereign Debt Crisis Wears On

The euro-area sovereign debt crisis continues to be the greatest global risk to the U.S. economy. Most pressing are a potential default of Greece, the weak banking system in Spain and overall sagging economic conditions in the euro area.

In a Nov. 27 meeting, euro-area finance ministers and the International Monetary Fund (IMF) agreed to provide €44 billion in loans to Greece, along with billions in debt relief. While this agreement prevented an immediate default, Greece continues to face austerity measures required per the bailout package. The forecast for Greece’s debt-to-GDP ratio for 2020 is 144 percent. The IMF agreed to raise Greece’s 2020 target to 124 percent from 120 percent in exchange for euro-area finance ministers’ commitment to reduce Greece’s government debt to 110 percent of GDP in 2022. Nevertheless, Greece is expected to extend its recession into a sixth year and faces an unemployment rate of 25 percent. Keeping in mind these considerations, Greece’s policymakers must overcome many challenges to reach the debt reduction goals set forth for them.

Spain and Italy are facing capital flight as investors demonstrate their lack of confidence in government bonds and other assets on the banks’ balance sheets. On Nov. 28, the European Commission agreed to Spain’s proposal to restructure four of its ailing banks to receive a payment of €37 billion from the European Stability Mechanism (ESM), the euro-area bailout fund. The four banks receiving the funds were all nationalized following Spain’s housing bust, which left them with a large amount of bad loans.

To avert financial crises in the future, euro-area leaders proposed the establishment of a single banking supervisor for the euro area. Talks on Dec. 4 failed to produce a resolution on how to give the ECB power to regulate the 6,000 banks in the region and create a barrier between financial crises and debt crises. Oversight by the ECB would allow troubled banks to draw money from the ESM without entrenching their government in more debt. On Dec. 12, euro-area finance ministers moved closer to reaching an agreement, but warned that failing to do so could have adverse consequences on investor confidence.

The euro area entered its second recession in four years as GDP fell 0.2 percent in the second quarter and another 0.1 percent in the third quarter. Growth expectations have deteriorated as the sovereign debt crisis wears down business confidence. Consensus Forecasts' predictions for 2013 real GDP growth in major euro-area countries have been revised downward considerably since May, especially in Spain (Chart 6).

Further concerns are the early resignation of Italy’s prime minister, Mario Monti, and the Bundesbank’s announcement that Germany may face a recession next year. With unemployment climbing and growth prospects faltering, economic recovery may be far off for the euro area as the rest of the world watches.

—Valerie Grossman

About the Author

Grossman is a research assistant in the Globalization and Monetary Policy Institute at the Federal Reserve Bank of Dallas.


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