World Economic Outlook
There are now increasing signs that the global slowdown, which began in mid-2000, has bottomed out and that a recovery is under way, according to the April 2002 World Economic Outlook, released at a press conference on April 18. Kenneth Rogoff, the IMF’s Economic Counsellor and Director of the Research Department, said that the IMF predicts global output growth of 2.8 percent for 2002 and 4 percent for 2003. Economic recovery is projected to be led by the United States, where GDP growth is expected to be 2.3 percent in 2002 and 3.4 percent in 2003 (see table, below).
In Europe, growth did not fall as sharply last year as in the United States, and the economic policy response was therefore less aggressive, so growth is expected to pick up a little later. Growth in the European Union is projected at 1.5 percent in 2002 and 2.9 percent in 2003. For Japan, the projected recovery is weaker and more fragile, with output declining by a further 1.0 percent in 2002 as a whole before rising by 0.8 percent in 2003. Rogoff pointed out that population growth in the United States is somewhat higher than in Europe and Japan, so that the per capita output growth projections are less different than the raw numbers imply.
As for inflation, Rogoff said, it is projected to be at record-low levels, reflecting both the recent slowdown and better policy credibility. The forecast for the advanced economies in 2002 is 1.3 percent—the lowest on record—and 1.8 percent in 2003. In the developing countries, inflation is also at a low 5.8 percent in 2002 (just above the 5.7 percent seen in 2001), then dropping to a record low of 5.1 percent in 2003.
Slowdown or recession?
Was the global slowdown a recession? Rogoff said that when reporters posed this question at the press conference for the October 2001 World Economic Outlook, the IMF did not have a view. But having researched the issue for the current report, the World Economic Outlook concludes—after looking at per capita output growth and several other variables, including world trade and industrial production—that while the years 1975, 1982, and 1991 did see global recessions, 2001 did not, even though it was a very close call. “It is,” Rogoff admitted, “a matter of semantics whether one wants to call this the mildest global recession in recent years, or the most severe downturn that was not a full-fledged recession.”
The U.S. National Bureau of Economic Research, he said, faced a similar quandary and opted to call the U.S. downturn a recession. Indeed, the U.S. downturn qualifies more clearly as an employment recession than as a full-fledged output recession. Employment growth was negative over several quarters, but since productivity growth held up unusually well—so that the same number of workers could produce more—output fell in only one quarter of 2001. This good news leads IMF staff to believe that its optimistic analysis in the October 2001 World Economic Outlook on productivity growth associated with the information technology revolution was correct, he added.
While the outlook is positive, Rogoff cautioned, policymakers need to remain alert to several possible risks.
Global imbalances. The first such risk is global imbalances, especially the persistent current account deficit in the United States (and associated low household saving rate) and surpluses of many of the other major countries. Indeed, since the United States is expected to lead the global economic upturn, the deficit may grow further. While the U.S. current account deficit is driven partly by high productivity growth in the United States relative to the rest of the world, it remains a significant concern because a sharp correction of existing current account imbalances resulting from a swing in capital flows could require a sharp realignment of exchange rates. Rogoff emphasized that the U.S. current account deficit is a global issue, not just a U.S. issue, and stronger growth in other industrial countries would help to correct it.
As to how this position squares with U.S. Treasury Secretary Paul O’Neill’s stance that the current account deficit is not a problem, Rogoff said—responding to a reporter’s question—that history gives reason for pause. While a country enjoying strong productivity growth and a strong inflow of investment is fundamentally in a good situation, it is also true that sustained current account deficits in the range of 4–5 percent of GDP are eventually reversed, with consequences—particularly in terms of the real exchange rate—that can be significant. During the 1980s, a similar situation arose: the U.S. current account was in deficit; there was a reversal of capital flows; the dollar depreciated sharply; and the effects were arguably not too favorable. It is hard to foretell what might happen today, Rogoff said, especially given the increasing sophistication and development of financial markets. So while we would not want to sacrifice growth to improve the current account balance, such a deficit is a vulnerability.
High corporate and consumer debt. A second area of vulnerability is the elevated level of equity prices compared with historical norms, as well as high corporate and consumer debt in many countries, as emphasized in the IMF’s recent Global Financial Stability Report. If the buoyant projections of recovery underlying current equity values were to disappoint, this could be a source of financial market vulnerability.
Japan. A third risk comes from Japan, mired in its third recession in a decade. Rogoff said that the IMF does not foresee Japan becoming an engine of growth for the global economy in 2002 or 2003; over the longer term, however, that is certainly possible. Prospects for productivity growth are good, provided that Japan presses ahead with structural reforms, including clean ing up its banking and corporate sector problems and addressing health service issues and expenditures in state corporations. Another important step is for the Bank of Japan to engage in an aggressive policy to end deflation as soon as possible. Ending deflation is an important objective as it will help support growth. Chapter III of the World Economic Outlook, on Recessions and Recoveries (see box, page 142), notes that the Japanese case is the only one in which recessions have been accompanied by deflation over the post-World War II era, although deflations were more common in earlier periods.
In response to a follow-up question on Japan from a reporter, Tamim Bayoumi, Chief of the IMF’s World Economic Studies Division, noted that the recently completed special banking sector inspections are a move in the right direction. These have led to a significant downgrade in the loans of the 149 large companies involved on the order of 7 trillion yen, or 1.5 percent of GDP. At the same time, it should be recognized that these companies cover only 4 percent of bank loans in Japan. The IMF staff continues to believe that a comprehensive assessment of all non-performing loans would lead to a significant reduction in the capital asset ratios of the Japanese banking system.
Noneconomic events. A fourth risk involves unforeseen noneconomic developments. The global economic recovery is expected to be solid, but events like those of September 11 could undermine confidence and stall the recovery. Oil price hikes are a dimension of this risk, as increases in oil prices can be linked to such events. Current spot and futures market prices for oil are roughly in line with the staff’s baseline projections of $23, on average, for 2002 and $22 for 2003. A sharp spike in oil prices would harm the global economy—the staff estimates that a price rise of $5 a barrel sustained for one year would cut global GDP by 0.3 percent. But the effect could be significantly larger if the increase in oil prices were accompanied by a significant noneconomic event.
Getting policy right
Policymakers’ records in recent years give reason to believe that these risks can be managed, Rogoff said. Indeed, the World Economic Outlook finds that part of the reason this slowdown was so mild is that economic downturns overall have become less marked over the past 15–20 years, thanks partly to better monetary policies and, possibly, to better fiscal policies. Rogoff commended the recent policy responses by the industrial countries, especially by the Federal Reserve Board and, to a lesser extent, the European Central Bank. The timing of the U.S. tax cut was fortuitous, while the euro area benefited from the flexible interpretation of the Growth and Stability Pact, which allowed the automatic stabilizers to work. Elsewhere, countries that reduced vulnerabilities—for example, by moving to more flexible exchange rates—tended to weather the storm better than countries with less flexible markets and a weaker macroeconomic policy framework.
Jacob Frankel reassured me that recessions are to an economist what plagues are to a mortician, but I nevertheless find this a much happier occasion.
Last, but not least, Rogoff noted, the IMF had helped. For example, soon after September 11, IMF Managing Director Horst Kohler encouraged the industrial countries to fight the downturn proactively and made it clear that the IMF would, in evaluating countries’ eligibility for IMF financial assistance, recognize the global nature of the shock that many developing countries were facing.
As the recovery picks up steam, Rogoff cautioned, industrial countries will need to balance the risks of inflation against the fragility of the recovery when conducting their monetary policy. Short-term real interest rates are very low and cannot be sustained indefinitely at these levels without generating inflation. One of the lessons of the recent downturn is that if you pay attention to your economy and take care of medium-term structural issues during the good times, it puts you in a much better position to weather downturns.
Rogoff said that he was happy to be able to present reporters with an upward-looking forecast after the difficult task of conducting his first World Economic Outlook press briefing just after September 11. “Jacob Frankel, who describes himself as my grandfather, reassured me that I shouldn’t worry, that recessions are to an economist what plagues are to a mortician,” Rogoff quipped. “But I nevertheless find this a much happier occasion.”