Global finances in better health, vulnerabilities persist
SLOWING ECONOMIC GROWTH ‘IS NOT A SIGN OF IMMINENT CRISIS’
Ten years from the global financial crisis, the global financial system is in much better shape and there are no imminent signs of a crisis of a global nature on the horizon, according to Randall S. Kroszner, deputy dean for executive programmes, and Norman R. Bobins Professor of Economics at the University of Chicago Booth School of Business.
Multilateral agencies such as the International Monetary Fund (IMF), the World Bank and various global financial institutions are projecting slower global economic growth, resulting in worries of a global economic slowdown of crisis proportions.
The latest update of the IMF’s World Economic Outlook (WEO) projects global growth at 3.5 per cent in 2019 and 3.6 per cent in 2020, 0.2 and 0.1 percentage point below last October’s projections.
Although downward revisions to global economic growth have been modest, the IMF believes the risks to more significant downward corrections are rising.
While economic growth has a strong correlation to the health of the financial system, Kroszner believes the slowing global growth can’t be entirely attributed to vulnerabilities in the global financial system.
“There isn’t any single factor that we can attribute to the slowing global growth,” Kroszner said. “Clearly economic growth is slowing in various parts of the world and fragilities in the financial system are just one part of the story.”
European woes
The euro area as a whole is facing a slowdown in growth with different countries facing varying problems.
Within the Eurozone the IMF has made significant downward revisions in growth for Germany, where production difficulties in the auto sector and lower external demand are expected weigh on growth in 2019.
In Italy sovereign and financial risks and the connections between them are adding headwinds to growth.
The linkages of Italy’s vulnerabilities are also adding to the risks faced by the wider Eurozone. In Britain, growth worries are linked to politics linked to Brexit, and in other parts of Europe the rise of ultra-nationalism and regional politics are threatening economic growth and stability. Excessive leverage and lack of fiscal discipline, according to Kroszner, will be at the centre of economic concerns in many emerging markets.
“In China there had been an enormous increase in leverage,” he said. “Now they are worried about the fragilities in the financial system and are trying to deal with that by bringing down the levels of leverage. That is resulting in a slowing of economic growth.”
Kroszner expects US economic growth to slow to about 2 per cent this year, from about 3 per cent last year.
This softening growth has provided little lift to inflation.
Core inflation is close to target in the US, where growth is still above trend and the economy is near full employment.
While financial markets, especially the equity markets, have been experiencing high levels of volatility, Kroszner said there is no evidence of an impending market crash.
Monetary policy, a key tool that determines the level of liquidity and cost of funds, is once again in focus as global growth decelerates.
The rate hikes and weaning away of economies off cheap money in advanced economies are having ripple effects in emerging market economies, amplifying their financial vulnerabilities and negatively impacting the growth momentum.
The IMF recently called on advanced economies to continue to normalise (monetary policies) carefully.
Rate hike implications
“The Fed clearly is mindful of the growth implications of rate hikes and has paused it for a while. If we look at the history of the recent rate hike cycle, the Fed has been extremely gradual and it has been successful in reducing the size of the Fed’s balance sheet,” Kroszner said.
Among the advanced economies, the US has been in a fortunate position to raise interest rates from zero to 2.5 per cent and rationalise the bond holdings on the Fed’s balance sheet.
“The US is in a much better position to deal with negative shocks compared to Europe and some other leading economies of the world,” said Kroszner.
By contrast, the European Central Bank (ECB) is still struggling with negative interest rates. Although the ECB may have stopped its asset purchase programme its balance sheet remains burdened with past purchases and the scope for rate adjustment remains dim, making it more vulnerable to a growth slowdown.