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IMF Senior Economist Wu Tao:

Recovery, Bottlenecks in 2014


Recovery, Bottlenecks in 2014


What does 2014 hold in store for the world economy? According to the IMF's Wu Tao, a modest but unmistakable recovery for the developed world, and straitened growth for emerging economies.



Recovery, Bottlenecks in 2014

By Elaine Huang
From CommonWealth Magazine (vol. 538 )

In its latest World Economic Outlook report, the International Monetary Fund (IMF) described the global economic trend in 2014 with the phrase "transitions and tensions." The report pointed out that the global economy is currently experiencing the most dramatic paradigm shift in more than a decade and that the global drivers of growth are shifting from the East to the West.

Wu Tao, senior economist at the IMF Institute and formerly for the U.S. Federal Reserve, analyzes the IMF's take on the world economy in 2014 in an exclusive interview with CommonWealth Magazine.

Following are highlights of the interview:

In 2014, the overall trend will be basically for the United States to recover quite strongly, the emerging economies to slow down, and the euro area to slowly pull out of recession. This means there are one strong and two moderate growth drivers.

In 2014, the growth engine for the global economy will be the United States. Not only is this the case next year, but it will stay that way for the coming five to ten years.

In the past, the outside world had strong doubts about the economic prospects of the United States because of the onslaught of the financial crisis. But the medium- and long-term growth prospects of the United States are the best of all large economies.

U.S. Recovery Strongest among Major Economies

In 2013, economic growth in the United States was not strong enough, partially because the budget deficit reduction hampered economic growth. We won't see this kind of situation happen again in 2014. As it looks now, U.S. government finances will not dramatically shrink due to deficit reduction; instead a constructive, more medium- and long-term fiscal adjustment strategy will be implemented. Therefore, U.S. fiscal policy will be able to support economic growth in 2014 more than in 2013.

Let's take a look at U.S. monetary policy.

First, the Federal Reserve will still maintain a zero interest rate. This will be the case at least until early 2015.

When the past few rounds of quantitative easing such as QE1 and QE2 were launched, there was a clear purchasing plan in the beginning. When QE1 was launched the Fed clearly stated a buying goal of US$1.25 trillion in mortgage-backed securities and US$300 billion in Treasury securities. But for QE3 the Fed did not state an end date and purchasing volume. Therefore, the financial markets have great misgivings about this kind of uncertainty.

On Dec. 18, the Fed already announced that QE3 will be scaled back by US$10 billion starting in January 2014.

But no matter how much the purchasing volume is cut back, there will still be net buying. Even if the program were scaled back to zero purchases and QE3 came formally to a halt, then the Fed would still hold more than US$4 trillion of Treasury notes on its balance sheet for one or two years and not start to sell the debt that it holds. As long as a zero interest rate is maintained and more than US$4 trillion in debt are on the balance sheet, the Fed's monetary policy stance will remain very loose.

In the coming years, the United States will be the most important growth driver for the advanced economies. While the labor market will be barely satisfactory during this period, the housing market will gradually recover, and purchasing power will also gain steam!!. Therefore, the U.S. economy will be stronger in 2014 and 2015 than in 2013. It will be the strongest among the large economies.

Emerging Economies Losing Steam

Growth in the emerging economies in 2014 and 2015 will be more or less the same as in 2013.

The IMF has markedly lowered its growth rate forecasts for emerging economies such as India, Brazil and Mexico. The major reason is that it is foreseeable that global money supply will gradually tighten. The emerging economies, in particular, will face tighter money supply. That's a short-term reason.

Then there are medium and long-term reasons. India, for instance, is gradually reaching a bottleneck on the supply side, and economic growth has reached its maximum potential extent, which will generate pressure on growth. Economic growth will not be very pronounced, and there will be inflationary pressure.

In 2014, many emerging nations will face growth bottlenecks, due to a process of medium- and long-term adjustment of the economic structure.

In China, for example, the new leaders clearly want structural adjustment, but not necessarily sustained growth. They have said this for more than ten years, so we need to wait and see how strong their determination is. They have launched many reform and adjustment measures. Based on this, they are not very likely to launch a new round of very strong financial stimulus policies.

But for many emerging nations, a piece of good news in 2014 will be that should the United States recover, this would benefit the exports of these nations.

A cross-analysis of various factors shows that growth in the emerging markets in 2014 will largely remain on the same level as in 2013. The stimulus effect on the global economy will not be as demonstrable as in 2013.

Japanese Growth Fades

As for Japan, we need to consider several factors for 2014. Japan will continue its quantitative easing policy, because when it was launched in early 2013 Tokyo announced that this would be a two-year program slated to run at least until the end of 2014, and that it would be continued further should the inflation rate not reach the 2 percent target in late 2014. This means that Japan's monetary easing will continue until the end of 2014.

But on the fiscal side, there are some pressures. Japanese debt stands at more than 250 percent of GDP. In the medium and long term Japan needs a fiscal adjustment strategy, or else debt will continue to increase, and we will easily get a debt problem similar to the European one.

On the other hand, Japan wants to raise the consumption tax in 2014, a move that is likely to have a constraining effect on private consumption and total demand.

But in Japan there is one variable that we need to keep in mind. The relatively strong GDP growth in Japan in 2012 and 2013 is partly owed to reconstruction in the wake of the earthquake of March 11, 2011. But these measures are nearing their end. In 2014 reconstruction spending will decrease a lot, which again will constrain real GDP growth.

If we look at the combined effects of both factors, Japanese economic growth in 2014 will fall behind growth in 2013.

The euro area, for its part, will slowly pull out of recession.

When we look at the euro zone we must divide it into two areas. One area is the core – for instance, Germany. The other is the periphery – Spain, Italy and so on.

In the core area, the economic growth rate was slightly above zero in 2013, and as conditions across the board are improving, the growth rate will slowly increase in 2014, for example, in Germany. On the periphery, the situation is somewhat more complex, but generally speaking, the crisis can be regarded as having come to an end, and the markets are more stable.

But the improved conditions in the financial markets have not yet translated into economic growth. The main reason is that during the financial crisis the situation of many companies and banks deteriorated massively. The banks are also saddled with a large amount of bad debt that they need to deal with. There is only a little room for granting new loans, so they will adopt a more conservative approach. Banks are more willing to grant loans to the core area. However, toward countries in the periphery, particularly customers whose assets and credit are not particularly good, such as small- and medium-sized companies, lending standards will rise.

Euro Zone Pulls out of Recession

Presently, the countries of the euro zone are negotiating the establishment of a banking union, and creating a new supervision regime and rescue mechanism. Under the new regulatory standards, requirements for interest rates and capital adequacy ratios will be higher than before. Therefore, banks will get more cautious about granting loans. This is also the reason why bank lending remains sluggish even now.

All in all, the euro area, particularly its periphery, is currently experiencing the symptoms of a classic credit crunch in the wake of a financial crisis. Based on past experience, regardless of whether we talk about the United States or Europe, the banking industry will go through a quite prolonged period of credit crunch following the financial crisis. The recovery will take a very long time.

But basically the situation in the euro area will not be worse than in 2012 and 2013. It is on an upward course. Although the speed [of recovery] is quite slow, it's at least not a decline.

The European bond crisis has become more stable. It is foreseeable that the European countries will relax their financial tightening a bit in 2014 and 2015. But since bank lending has become more prudential, we cannot hope for very vigorous growth.

Translated from the Chinese by Susanne Ganz

Wu Tao

Year of birth: 1972

Education: Ph.D. in economics from Yale University

Professional experience: Senior Research Economist and Policy Advisor, Federal Reserve Bank of Dallas; Research Economist, Federal Reserve Bank of San Francisco