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Globalization & Monetary Policy Institute
International Economic Update

Global Growth Outlook Weaker but Still Positive

July 31, 2014 · Update in PDF PDF

The world growth outlook remains positive but has weakened slightly with recent data releases, especially in emerging economies. The International Monetary Fund (IMF) has reduced its forecast for 2014 global growth from 3.7 percent to 3.4 percent but kept its forecast for 4 percent growth in 2015 unchanged. Global risks include the expanding credit market in China, labor market slack and low inflation in the euro-area periphery, and the fledgling recovery in Japan.

Emerging Economies’ GDP Forecasts Downgraded

The gap between advanced and emerging economies’ GDP growth has narrowed, with 2.2 percent growth year over year in advanced economies and 3.8 percent growth in emerging economies in first quarter 2014 (Chart 1). The IMF lowered its 2014 GDP growth forecasts for many large emerging markets in July. Russia’s expected growth was lowered from 1.3 percent to 0.2 percent due to the crisis in Ukraine, Brazil’s forecast was cut from 1.9 percent to 1.3 percent, and China’s economy is expected to grow 7.4 percent instead of 7.6 percent.

Chinese Credit Expands, House Prices Continue to Fall

Even with the downgraded forecasts, China’s economy seems to have picked up some steam after a slight deceleration in the first quarter. Despite continued softness in construction and the housing market, China’s second-quarter output growth surpassed expectations, meeting the government’s growth target of 7.5 percent. Some of the growth is attributed to expanding credit and increased government spending. Total social financing, a broad measure of lending in China, increased in June for the third consecutive month, reflecting the continued increase of credit supply. While credit continues to expand in China, house prices declined again in June, placing more strains on the credit market. Since March, house prices have declined almost 1 percent, the largest quarterly decrease since 2012 (Chart 2).

On July 15, Brazil, Russia, India, China and South Africa (the BRICS countries) agreed to establish a New Development Bank (NDB) headquartered in Shanghai at their annual BRICS summit meeting. The aim of the NDB is to act as an alternative international financial system to the IMF and the World Bank to encourage economic cooperation among the BRICS countries. The NDB will start out with $50 billion in capital to finance infrastructure projects and will also include a $100 billion currency reserve to provide added liquidity protection during balance of payments crises.

Advanced Economies on Different Trajectories

Advanced economies have gained strength relative to emerging economies because of continued improvements in the U.S. and in the U.K. GDP in the U.K. expanded by 3.1 percent year over year in second quarter 2014, following 3.0 percent growth in the first quarter, and the June manufacturing Purchasing Managers Index (PMI) came in above 57 for the third consecutive month. The economy’s GDP has now surpassed its prerecession peak, supporting expectations that the Bank of England will begin tightening monetary policy early next year.

Indicators in the euro area are still mixed, but economic activity picked up in July. The euro area’s composite PMI edged up to 54.0 in July from 52.8, and Spain’s June manufacturing PMI was the highest since 2007 at 54.6. However, the unemployment rate in the euro area remains at 11.6 percent (in May), and disparities in unemployment rates across the region are still very large, with core unemployment at 7.0 percent and the periphery rate at 15.2 percent (Chart 3).

The recent uptick in economic activity follows the European Central Bank’s (ECB) June stimulus measures, which included a negative interest rate on deposits that lenders have at the central bank and targeted long-term refinancing operations to support growth, lending and a slumping inflation rate. Consumer price index (CPI) inflation in the euro area held steady at 0.5 percent in June, significantly lower than the ECB’s inflation target of just below 2 percent. ECB President Mario Draghi said at the July 3 meeting that quantitative easing is still on the table if medium- or long-term inflation expectations change. For now, the ECB is expected to hold rates steady while assessing whether the measures imposed in June increase inflation.

Japan is also trying to boost inflation, but CPI inflation for all items ticked down slightly from 3.7 percent to 3.6 percent in June (Chart 4). The increase in the CPI over the last few months is clouded by the April sales tax hike from 5 to 8 percent, leaving evidence of a Japanese recovery mixed. After solid output growth in the first quarter from consumers front-loading their purchases before the tax hike, demand appears to be slowing, and there is uncertainty about whether the subsequent economic slump will end soon enough to protect the fledgling inflation.

Monetary Policy Likely to Diverge

Growth in emerging economies depends on demand growth from advanced economies and will continue to deteriorate until the euro area and Japan are on solid footing. The varying levels of recovery pose diverse challenges for the major central banks. While Japan and the ECB press on with monetary easing, the U.S. and the U.K. will begin to consider tightening their policy to prevent overheating.

—Valerie Grossman

About the Author

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


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