Raising economy’s speed limit poses policy challenge
Global finance chiefs are trying to soup up their crisis-hit economic engines. How to do so was a theme of weekend talks of the International Monetary Fund’s spring meetings in Washington as economists from JPMorgan Chase & Co estimate the financial crisis and subsequent world recession knocked the potential growth rate of rich countries down to about 1.5 per cent from two per cent.
Such a decline in the speed limit of the growth rate at which inflation ignites is troubling because it risks pressuring central banks to raise interest rates sooner than they might otherwise want. The weaker potential also hurts the ability of businesses to boost profits, workers to win pay increases and governments to cut debts.
“It is clear to me and not just to the IMF but many other players around the world that there is a real signifi- cant potential” to be tapped, IMF Managing Director Christine Lagarde told Bloomberg Television’s Tom Keene in Washington.
The debate marks a pivot after six years of worrying over how to spur demand to considering how to increase the supply side of economies so they can handle faster expansion. While growth rates for a time can exceed potential — which is determined by the growth of the labour force and of worker productivity — it cannot do so for an extended period. The IMF predicts advanced nations will grow faster than two per cent this year for the first time since 2010.
“Driving growth that creates jobs and raises living standards is now the top priority for the global community, and that focus marks a turning point in the global recovery,” US Treasury Secretary Jacob J. Lew said.
Singapore Finance Minister Tharman Shanmugaratnam said there is now “a focus on the medium term more than the short term, and a much greater focus on structural reforms.”
The challenge they face was illustrated in a presentation by Bruce Kasman, chief economist at JPMorgan. His estimates show the potential rate of developed economies is about 5.2
There’s no easy way to grow the world economy Joe Hockey
per cent of gross domestic product below what it would have been had the 2008 trend held intact. In a sign demand still remains weak, the new trend is still about four per cent of GDP above current performance.
What Kasman called a “chronic supply-side crisis” was evident in other calculations which showed the proportion of the working age population in jobs has slid to about 54 per cent from almost 56 per cent before the crisis. Investment as a share of GDP has dropped to about 20 per cent from about 22 per cent.
Putting another name to the outlook is former US Treasury Secretary Lawrence Summers, who has revived the term “secular stagnation” as a warning of what may await rich nations if their governments fail to invest more to increase the capacities of their economies. Low borrowing costs and double-digit unemployment for construction workers suggest no obstacle to the US government spending on infrastructure, he argues.
“A soft economy casts a substantial shadow forward onto the economy’s future output and potential,” Summers said on April 1.
After spending recent years advocating stimulus, the IMF is also tuning into the supply-side weaknesses. In speeches and reports over the last week, its officials argued weaker trend expansion would make it harder for governments to restore fiscal order and that a failure to revive investment or mop up the supply of workers would spell permanent economic weakness.
Possible solutions include revamping how labour markets work, increasing competition and productivity in non-tradable sectors, paring the size of governments and looking to improve state spending, IMF chief economist Olivier Blanchard said. The lender estimated in February that reforms could add $2.25 trillion to the global economy by 2018.
“There’s no easy way to grow the world economy,” said Australian Treasurer Joe Hockey. “Easy monetary policy is inevitably sooner or later going to end and governments haven’t got the fiscal capacity to keep throwing money. The third leg to the stool has to be structural reform, and that’s not politically easy, it’s hard.”
Not all are worried. UK Chancellor of the Exchequer George Osborne recommitted to fiscal austerity and rejected Summers’s case for more government spending.
“The pessimists are on the march again with their predictions of stagnation,” he said. “We, the optimists, can prove them wrong again.”
Central bankers in Washington also trained their eyes on the lack of current demand, as represented by the gap between potential and actual growth. —