The IMF’s January 2014 World Economic Outlook Update has three main messages:
First, the recovery is strengthening. We forecast world growth to increase from 3 percent in 2013 to 3.7 percent in 2014. We forecast growth in advanced economies to increase from 1.3 percent in 2013 to 2.2 percent in 2014. And we forecast growth in emerging market and developing economies to increase from 4.7 percent in 2013 to 5.1 percent in 2014.
Second, this recovery was largely anticipated. We have revised our forecast for world growth in 2014 by just 0.1 percent relative to our October forecast. The basic reason behind the stronger recovery is that the brakes to the recovery are progressively being loosened. The drag from fiscal consolidation is diminishing. The financial system is slowly healing. Uncertainty is decreasing.
Third, it is still a weak and uneven recovery. Among advanced economies, it is stronger in the US than in Europe, stronger in the euro core than in Southern Europe. In most advanced economies, unemployment remains much too high. And downside risks remain.
The recovery is far from even.
US growth appears increasingly solid. Private demand is strong. As a result of the December budget agreement, fiscal consolidation, which weighted on growth in 2013, will be more limited in 2014. These factors lead us to forecast 2.8 percent growth for 2014, compared to 1.9 percent in 2013. While monetary policy remains very accommodative, the focus is increasingly turning to monetary policy exit, and we expect the policy rate to rise in 2015.
Japan grew at 1.7 percent in 2013, and we forecast the same growth rate for 2014. This is good news. But this growth has come largely from fiscal stimulus and from exports. For growth to be sustained, consumption and investment have to take the relay. And the Japanese government will continue to face the challenge of achieving enough fiscal consolidation to reassure debt holders while not slowing down the recovery – a difficult challenge.
Conditions are increasingly favourable in the UK and the Eurozone core nations. Public debts are on sustainable paths, and fiscal consolidation is, rightly, slowing down. Credit conditions are favourable. This leads us to predict growth of 2.4 percent for the UK, 1.6 percent for Germany, although only 0.9 percent for France, where confidence is still low.
Southern Europe continues to be the more worrisome part of the world economy. We forecast positive growth for 2014, but this growth is fragile. On the one hand, exports are strong. On the other hand, internal demand is weak, suffering from the loops between weak activity, weak banks, weak firms, and the need for fiscal consolidation. Sustained growth will require cutting those loops, and relying both on external and internal demand.
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We forecast that growth in emerging market and developing economies, while lower than in the past, will remain high. On the one hand, these countries will benefit from higher advanced growth in advanced economies. On the other, as US monetary policy normalises, they will face tighter financial conditions.
We believe that, for most countries, the first effect will dominate the second. On the internal front, perhaps the main challenge is faced by China, which needs to contain the building of risks in the financial sector without excessively slowing growth, a delicate balancing act.
We see two main risks to the outlook.
First, as the recovery takes hold in advanced economies, a main challenge will be to normalise monetary policy. While some of this expected normalisation has already been priced in both long rates and exchange rates, we can expect complex and sometimes disruptive capital movements across countries for some time to come.
In that environment, the evidence from last year is that emerging market economies with weak macro frameworks may be most affected. What we need to decrease this risk is both clear communication by advanced economies’ central banks, and stronger domestic policies in those emerging market economies under stress.
Second, while our baseline forecasts are for low but positive inflation in the Eurozone, the risk is that inflation turns into deflation. There is nothing magical about the number zero – when inflation turns to deflation. But the lower the inflation rate, and a fortiori the larger the deflation rate, the more dangerous it is for the Eurozone recovery.
Deflation means higher real interest rates, higher public and private debt burdens, lower demand, lower growth, and further deflation pressure. To avoid that risk, accommodative monetary policy by the ECB remains of the essence. And so is the strengthening of banks’ balance sheets. In this respect, carrying out the balance sheet assessment and stress test process now under way may be the most important short-term task facing the euro area today.
In short, recovery is indeed strengthening. But much work remains to be done.
By Olivier Blanchard