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Special Topic: Global Economic Outlook

More than five years after the initial onset of the global financial crisis in August 2007, the world economy is still performing below expectation. There was a rebound in growth in 2010 from the sharp dip in 2009 when the impact of the crisis was greatest. Since then, however, world growth has been below expectation, although favourable compared with the 1990s, largely because of faster growth (and so increasing shares of world output) in developing economies (Figure 1). But advanced economies have performed poorly in 2011 and 2012 relative to previous decades.

Figure 1 - World economic growth
Figure 1 - World economic growth.
Source:  International Monetary Fund, October 2012 WEO

As growth has continued to fall below expectation, forecasts have been revised down. The latest International Monetary Fund (IMF) World Economic Outlook (WEO), released at the annual meeting of the Fund in Tokyo in October, is no exception. This special topic presents the main points from those forecasts, including the risks.

World growth in 2012 has fallen short...

World economic growth in the first half of 2012 was below IMF's previous forecast in April. The IMF puts forward several reasons for this: the continuation of the euro debt crisis creating increased uncertainty, weak financial institutions curtailing credit growth, and inadequate policy responses in key developed economies; in addition, domestic constraints (in the form of capacity pressures and financial imbalances) have limited growth in emerging and developing economies. The IMF also acknowledges that fiscal consolidation may have had a greater impact on growth than it had previously estimated.

...and forecasts have been revised down...

The latest WEO forecasts for world output growth contain further downward revisions. Growth is now expected to be 0.2% points and 0.5% points lower for 2012 and 2013 respectively than in the forecasts presented in April 2012 (Table 1). The reasons for the downward revisions are the same as for the recent slow growth, discussed above.

Table 1 - World growth forecasts (annual growth %)

Calendar years 2011a 2012e 2013f
April 2012 WEO 3.9 3.5 4.1
July Update 3.9 3.5 3.9
Oct 2012 WEO 3.8 3.3 3.6

Source: International Monetary Fund

Forecasts for growth in New Zealand's main trading partners have also been gradually revised down, particularly since mid-2011. Figure 2 below shows Consensus forecasts, weighted according to shares of New Zealand goods exports, for 2012 and 2013, updated each month. The median forecast for 2012 fell by 1% point in the second half of 2011 from 4.4% to 3.4% (where it still sits) and the outlook for 2013 was revised down from 4.0% to 3.5% in the past six months.

Figure 2 - NZ's trading partner growth forecasts
Figure 2 - NZ's trading partner growth forecasts.
Source:  Consensus Economics

...partly because of policy weakness

The IMF makes the point that part of the reason for the under-performance of the world economy in the first half of 2012 was the lack of an adequate policy response to the euro debt crisis and the fiscal problems in the US. Their latest forecasts are also predicated on the assumption that these issues will be addressed satisfactorily and that if they are not "global activity could deteriorate very sharply."

Outlook weaker now and risks greater...

In its latest forecast, the IMF emphasises that not only is the outlook weaker, but the downside risks are greater than before. Despite recent moves to stabilise the situation, the main risk is of a further escalation of the euro debt crisis. The IMF models the impact of reduced credit, higher sovereign risk premiums in the periphery, larger fiscal consolidation in the peripheral economies and higher corporate risk premiums in advanced and emerging economies. Output in the core euro economies would be nearly 2% points lower than in the baseline forecasts under such a scenario and about 6% lower in the peripheral economies within one year. The IMF also allows for a faster resolution of the euro crisis in an upside scenario.

The other major downside risk considered by the IMF is a failure to resolve the scheduled fiscal tightening in the US at the beginning of 2013. The resultant fiscal contraction would likely plunge the US into recession, which would be transmitted to the rest of the world economy through confidence and wealth effects.

...including medium-term risks...

The IMF also considers two specific medium-term risks that might affect the outlook for the world economy. The first risk is that monetary easing (through the expansion of central bank balance sheets) might lead to higher inflation and lower growth. The second specific risk is high public debt which might constrain growth through higher interest rates, or lead to higher taxes and/or lower public investment, or raise risk premiums for some countries, thereby constraining growth.

...and lower potential output...

The IMF also discusses a general medium-term risk to the outlook. They note that repeated under-performance of the world economy relative to expectations may point to medium-term weakness in potential output (i.e. the productive capacity of an economy, or the level of output in an economy which is consistent with stable inflation). The IMF projections already incorporate a level of potential output for advanced economies that is around 10% lower relative to the pre-crisis trend (1996-2006) in 2012 (Figure 3). Estimates for emerging economies are similar to pre-crisis trends, but projections for medium-term output have been revised down over the past year.

Figure 3 - Advanced economies' level of output
Figure 3 - Advanced economies' level of output.
Source:  IMF, October 2012 WEO

Potential output could be even lower over the medium term, which would mean there is less slack for these economies to grow before they run up against capacity constraints. IMF modelling suggests that if potential output growth is 0.5% p.a. lower in the US, euro area and Latin America and 1% lower in Asia, global growth for 2013-16 would be 1.5-2% points lower than in the baseline forecasts of 4-5% growth.

...with implications for New Zealand

The IMF discussion shows that the continued downward revision of forecasts is not simply "forecast error" but reflects a lack of resolute action on the part of policy-makers around the world. The performance of the world economy could fall short of expectation again in the forecast period if the assumed action is not taken, with consequences for New Zealand's economic performance. In addition, if global potential output is weaker, that would affect New Zealand through lower global growth and weaker external demand for our goods and services.

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