The latest from the guardians of economic policy orthodoxy
This article is an on-site version of Martin Sandbu’s Free Lunch newsletter. Register here to receive the newsletter directly in your inbox every Thursday
Thanks to my colleague Claire Jones for keeping Free Lunch going while I was away, with her thought-provoking pieces about how much we should really fear for banks and about how the EU You risk losing your lead. on the transition to a zero carbon economy.
Being away means I’ve also missed the spring meetings of the IMF and World Bank, so I can’t report firsthand on the current sentiment among the global policymaking elite. (Consult my colleagues Gillian Tett and cris giles for that.) But as longtime Free Lunch readers know, I find it useful to examine the analytical arguments that international institutions focus on in their flagship reports, as these often set the intellectual premises for national and international policy debate. international. Here are the main points that caught my eye while flipping through this month’s posts.
First, where is the world economy headed? The overall outlook isn’t great, but no bleaker than before (although, as Chris Giles has explained, we must take these forecasts with a grain of salt.) But take a closer look at the “tail risks” in the IMF’s analysis, the really bad outcomes that fund economists think are possible, though not the most likely. He World economy perspectives puts a one in seven chance of a “severe downside scenario” involving a credit crunch that would lead to global growth of no more than 1 percent per year. That is a huge downside risk to the global economy!
And it gets worse. From the fund’s Global Financial Stability Report, learn the following:
“Our growth-at-risk metric, a measure of the risks to global economic growth from financial instability, indicates a 1 in 20 chance that global output will contract 1.3 percent over the next year. Gross domestic product is just as likely to fall by 2.8 percent in a severe tightening of financial conditions in which corporate and sovereign spreads widen, equity prices fall, and currencies weaken in most emerging economies.
A few weeks before the meetings, warned the World Bank that the sustainable growth rate of the global economy would slow to just 2.2 percent by the end of the decade, a third less than at the beginning of the century.
Even if these poor results do not materialize, international financial institutions are clearly in “risk aversion” mode. Exuberance, whether rational or not, is nowhere to be seen.
Second, what about persistent inflation and rising debt, two of the most frequently mentioned concerns by politicians and economic observers? The fund’s policy message is conventional enough: Keep interest rates high and tighten government budgets to reduce inflation and control debt.
What I find curious is that this conventional message comes together with important observations that could at least be recognized as a move in the opposite direction. The IMF believes that interest is “neutral” rates will stay low, implying that current monetary policy is already very tight. Is World Economic Outlook results “there are no signs of a wage and price spiral” and documents that inflation expectations are no higher than before the pandemic. As for the debt, meanwhile, his investigation makes a great point how it is easier to reduce it during a boom, and shows how inflation has already helped achieve some significant improvements in the public debt burden. In the graph below, the country that has reduced the debt to GDP ratio by more than 20 percentage points in just one year is Greece!
Given all this, one might think that we should worry a little less about inflation and a little more about not slowing down growth. But no, the chief economist of the IMF Pierre-Olivier Gourinchas describes the fact that the banking turmoil will slow down economic activity as a “silver side”.
On debt, by the way, the prospects are not entirely bad. The fascinating chart reproduced below shows that the rise in global debt is mostly driven by the US and China. If these two economies are excluded, the debt-to-GDP ratios of advanced and emerging economies are forecast to fall or remain stable, respectively; the debt burden of low-income countries is also expected to decline.
Even those averages could, of course, include some cases with serious problems. And in “low-income developing economies, higher borrowing costs are also weighing on public finances, with 39 countries already in or close to debt distress.” It is to the credit of the IMF that it repeatedly mentions that debt restructuring should be considered in the policy menu.
The third big issue in the global economic policy debate is “decoupling” (between China and the US) or “fragmentation” (more generally). The fund has done us the favor of mapping part of the territory and estimating the economic cost of a less integrated global economy.
While we mainly talk about trade when we look at fragmentation, the IMF helpfully asks us to look at other economic linkages, particularly foreign direct investment, where cross-border activity has actually declined (unlike trade).
To do so, the World Economic Outlook presents a very clever measure of “political distance,” defined by voting records in the UN General Assembly. Applying this measure to FDI flows over time, the report sets that an increasing share of cross-border direct investment takes place between politically similar countries. The same goes for geographic distance. And in “strategic” sectors such as semiconductors, the number of foreign investments in China has halved in less than a decade.
What would be the cost of such “friendshoring”? The IMF estimates efficiency costs of 2 percent of world GDP, but divided very unevenly between countries. The greatest economic impact of decoupling or fragmentation would be felt by emerging and developing economies. Also in more volatile financial flows, the fund examines the risk of fragmentation. He GFSR finds that greater political distance reduces not only FDI, but also portfolio financing and bank flows.
What to do with all this? Perhaps simply that the signals from the global economy are mixed. But as one of my graduate school professors, a former US presidential economics adviser, taught me in my first macroeconomics class, “In economics, to be deeply confused is to be deeply informed.”
News of numbers
The OECD has published a raw materials report critical to the green transition, documenting the concentrated supply that has caused Western countries to seek policies to reduce import dependency.
Nearly $80 billion of Chinese infrastructure loans in countries that partnered with its Belt and Road initiative went wrong in the last three years. That’s four times more than the previous three-year period. Beijing has issued tens of billions more in bailout loans to prevent borrowers from defaulting.