What happens when the US is no longer the world’s ‘consumer of last resort’? Uniquely, its balance of payments current-account deficit is slowly contracting during this recovery rather than expanding rapidly. This might seem like good news. But if the US no longer performs its traditional ‘last resort’ role, who else can?
Until recently, it was China. Yet as its economy boomed, Beijing discovered that credit growth was excessive, infrastructure projects’ rates of return declined, and risks of future economic instability rose. With its focus shifting from the quantity to the quality of growth, China too is no longer willing or able to play the consumer of last resort role.
Many emerging nations exceeded expectations in recent years, with growth above their long-run supply potential
Japan did its bit in early 2013, helped by the expansionary effects of Abenomics, but subsequent growth has been weak. Before the eurozone crisis, countries in Southern Europe were, in effect, miniature consumers of last resort, experiencing rapidly deteriorating current-account deficits thanks to hot money inflows, primarily from Northern Europe.
More recently, emerging economies found themselves in a similar position, subjected to rapid capital inflows that boosted domestic demand, squeezed competitiveness, widened current-account deficits and reduced the incentive for supply-side reforms. The damaging consequences are falling currencies, weak stock markets, rising short-term interest rates and slowing growth.
It is becoming increasingly clear that a trade-off exists between the short-term benefits of monetary expansion and its longer-term costs.
Many emerging nations exceeded expectations in recent years, with growth above their long-run supply potential – possibly because of a global ‘hunt for yield’ fuelled by the developed world’s growing addiction to monetary stimulus. But by driving down interest-rate spreads, demand picked up even as supply-side reforms were postponed.
And loose monetary conditions may have contributed to underlying weaknesses in developed countries too. The unusually low level of bankruptcies in some countries, given the substantial loss of output, might suggest inefficient companies survived, making it harder for more dynamic start-up ventures to gain a foothold.
There are huge political uncertainties in the global economy. After the initial financial fallout over Ukraine we lowered our forecasts for Russia’s growth in 2014 from 2 per cent to 0.6 per cent and from 2 per cent to 1.2 per cent for 2015. However, a tit-for-tat outbreak of sanctions – including disruption of Russian gas supplies to Europe – could prove much more damaging.
Other emerging markets are experiencing adjustments similar in nature, if not in scale, to Southern Europe’s. We have substantially reduced our growth forecasts for Turkey, South Africa, Thailand, Singapore and parts of Latin America. Our forecasts for this year’s emerging-market growth have been cut from 4.9 per cent to 4.7 per cent.
There are still considerable uncertainties about China’s near-term outlook. Long-term reforms may mean short-term pain but we remain confident Beijing can deliver any fine-tuning required. Our forecasts for growth are unchanged at 7.4 per cent in 2014 and 7.7 per cent next year.
In the developed world, Japan is disappointing while the UK surprises on the upside; the eurozone faces a deflationary threat while the underlying US position was clouded by bad weather in early 2014.
Overall, with no region of sufficient size able to play the role of consumer of last resort our global forecasts remain lacklustre and a disinflation bias persists. Still, while monetary policy remains aimed primarily at engineering a decent recovery in economic activity, we shouldn’t lose sight of the dangers of persistently easy monetary conditions: history shows all too clearly that a persistent reliance on monetary stimulus ultimately threatens financial instability.
This research was first published on 20 March 2014.