GLOBAL RECOVERY CONTINUES, but at an ever slowing and increasingly fragile pace. Several stresses of economic origin threaten economic activity.
Not only do these developments lead us to a further broad-based reduction in our baseline projections for economic growth in 2016 and 2017; they also suggest that possible non baseline outcomes are at the same time less favourable and more likely.
Notwithstanding this cloudier picture of economic fundamentals, financial markets in advanced economies have, at this writing, partially reversed their swoon of the first weeks of 2016.
Some improved data releases, a firming of oil prices, lower capital outflows from China, and decisions by major central banks have all contributed to improved sentiment.
These developments are consistent with our central projection that growth over the next two years, while lower than we believed likely just a few months ago, will still be slightly higher than in 2015. Yet that outcome is far from assured. Significant downside risks remain, and events that make those risks more salient may well trigger renewed financial turbulence.
What are the risks? Important among purely economic risks is a return of financial turmoil itself, impairing confidence and demand in a self-confirming negative feedback loop. Despite the recent rebound in asset prices, financial conditions in the United States, Europe, and Japan have been on a tightening trend since mid-2014.
Yet financial conditions have tightened even more outside the advanced economies. Increased net capital outflows from emerging markets – the subject of market perceptions of constrained macroeconomic policy space added to the recent bout of pessimism.
These worries remain and are especially relevant for emerging market and developing economies. Another threat is that persistent slow growth has scarring effects that themselves reduce potential output and with it, consumption and investment.
Consecutive downgrades of future economic prospects carry the risk of a world economy that reaches stalling speed and falls into widespread secular stagnation. Adding to this list are several pressures with origins in political, geopolitical, or natural developments.
Structural reforms in product and labour markets can be effective in boosting output, even in the short term, and especially if coupled with fiscal support.
Tax reform, even when budget neutral, can create demand if well targeted, while simultaneously improving labour force participation and enhancing social cohesion. Not only financial stability, but the transmission of monetary and fiscal policy, would be enhanced by further financial reforms, including the resolution of impaired assets still held on banks’ books.
These measures should be taken now, but countries should also cooperate to design collective measures to be deployed in the future in case downside risks materialise. A range of demand- and supply-side policies can be more effective through positive output spillovers across countries; policymakers could already formulate contingent plans.
In addition, cooperation to enhance the global financial safety net and the global regulatory regime is central to a resilient international monetary and financial system. The current diminished outlook and associated downside possibilities warrant an immediate response.
If national policymakers were to clearly recognise the risks they jointly face and act together to prepare for them, the positive effects on global confidence could be substantial. The result would be stronger growth under the baseline outcome as well as insurance against a derailed recovery.
Maurice Obstfeld is economic counsellor at the International Monetary Fund (IMF). He shared these views in the IMF’s latest World Economic Outlook, which was released last week.