EconoMonitor

Prospects for the Global Economy in 2013

CFR’s A. Michael Spence thinks that 2013 augurs better for the world economy, but cautions that lagging employment and income inequality will hamper a robust recovery.

In contrast, CFR’s Robert A. Kahn cautions that Europe’s debt crisis is far from being solved and that without growth, “we are likely to see Europe again at the brink.” The Century Foundation’s Mark Thoma believes that a reevaluation of monetary policy in the United States, and possibly the Bank of England, could help lower the European Central Bank’s guard against inflation in the coming months.

A. Michael Spence, Distinguished Visiting Fellow, Council on Foreign Relations

The economic outlook for the United States in 2013 is marginally brighter. The economy is adapting structurally, albeit slowly, to an altered and more sustainable growth pattern. The deleveraging process is further along, which, in turn, has spurred domestic demand. A divided Congress appears to be serious about reducing debt and long-term non-debt liabilities, and may come together around a credible stabilization path that will reassure business, reduce uncertainty, and boost investment. However, disruptive technology, global market forces, the education gap, and skills deficit mean that long-term unemployment will remain a problem. Looser monetary policy, designed to buy time for politicians to enact needed policy changes, may push the economy back toward the defective leveraged-growth model and delay long-overdue structural adjustments.

Europe experienced a substantial decline in systemic downside risk in the summer of 2012 as a result of credible reform momentum in Italy and Spain, as well as conditional but strong commitment by the ECB and the eurozone core to stabilize the banking sectors and the sovereign debt markets while those reforms take effect. Political uncertainty surrounding upcoming elections may cause a setback, but the most likely outcome is negative growth and high unemployment (especially for the young), not a disorderly unwinding of the eurozone.

Generally, the emerging economies look to be faring better. In 2012, the ongoing crisis in the eurozone retarded growth, but it did not completely derail development. China, entering the complex middle-income transition, experienced a bout of systemic risk associated with its leadership transition and a decade-long decline in reform momentum. That risk has declined with a successful leadership handoff and early signs of a forceful commitment to reduce corruption, alter the role of government in the growth model, and to deal with major social issues.

On the whole, the global economy, while not yet free of downside risk, appears set for a year of transition to better-balanced economic growth, albeit with lagging employment and income inequality continuing to hamper a robust recovery.

Robert Kahn, Steven A. Tananbaum Senior Fellow for International Economics

Europe’s challenge for 2013 will be sustaining support for economic reform, maintaining market confidence, and making progress on a banking and fiscal union. This will require, above all, growth. On this count, there is reason for pessimism.

The International Monetary Fund projects only 0.2 percent growth in Europe next year, and many private forecasters are more pessimistic. A weak global environment means exports may be less of a driver for growth than it was in 2012. Domestic demand has stalled and will continue to be damaged by planned fiscal consolidation and a weakened financial system that is hesitant to lend. The looming fiscal cliff in the United States, as well as growth uncertainties in Asia, add to the downside risks.

Against this backdrop, markets, and politicians continue to operate on different timelines, with markets demanding quicker action than European policymakers have been willing to provide. More progress is needed on reducing debt in the eurozone periphery, but Germany is unwilling to address the problem before its September 2013 elections. Banking reform is similarly on a slow track: while an agreement has been struck on a single supervisory mechanism, it will not be implemented before 2014, and a full banking union remains a distant goal. Add in continuing concerns over a Greek exit from the EMU, uncertainty surrounding Italian elections, and growing opposition to reform throughout the periphery after years of deep recession, and you have a volatile mix.

In 2012, the ECB’s announcement of a new bond purchase facility, coupled with its liquidity policies, provided breathing space from the crisis. However, markets may not be so kind next year if growth falters, adjustment efforts in the periphery remain under pressure, and negotiations to strengthen the monetary union continue to move at a snail’s pace.

A return to growth would provide confidence that reform can be sustained, economic targets met, and debt levels will remain sustainable. Without it, we are likely to see Europe again at the brink.

Mark Thoma, Fellow, The Century Foundation

Ever since the double-digit inflation problems of the 1970s, the U.S. Federal Reserve has reacted strongly to any sign of inflation and avoided policies that might lead to hyperinflation. This high degree of sensitivity to inflation appeared to work well in the period from 1984 to 2007, known as the Great Moderation. But when the Great Recession of 2007-2009 hit, worries about inflation put a constraint on the Fed’s ability to aggressively attack our unemployment problem. In retrospect, the Fed was too timid: with so much slack in the economy, worries about inflation were overblown, and a more aggressive response to the unemployment problem would have been possible.

One of the most important emerging trends in macroeconomic policy is the movement toward central bank operating procedures that are more tolerant of the temporary increases in inflation needed to effectively fight unemployment in deep recessions. The Fed’s recent announcement that it is willing to allow inflation to drift above its 2 percent target as it battles unemployment is an example of this change in thinking. That’s a big departure from the Fed’s previous policy, by which it appeared unwilling to allow the target inflation rate to be exceeded at all.

This reevaluation of monetary policy in light of the experience of the Great Recession is not limited to the United States. Bank of Canada Governor Mark Carney, for example, recently hinted that he may employ similar monetary policies when he takes over as governor of the Bank of England in July of 2013. While he will still have to convince others on the monetary policy committee to adopt his views, he was chosen to shake things up, and certainly brings a more dovish outlook to the policy table.

Will this spread to continental Europe as well? Because of the hyperinflation in Germany’s history, there is considerable resistance to lowering the European Central Bank’s guard against inflation. But if these policies work in the United States and the United Kingdom, as I believe they will, the spread of these new ideas to the ECB and beyond is inevitable.

This piece is cross-posted from Council on Foreign Relations with permission.

2 Responses to “Prospects for the Global Economy in 2013”

Texsbill GranJanuary 2nd, 2013 at 10:33 am

capialism is wunderful form os economics. democracy is greatest form of government. trouble is in their execution & implementation in the usa. wealthiest individuals, largest corporations, & their agents receive most of the benefits n advantages of capitalism & democracy over the past 40 years.

Cyprus BankingApril 24th, 2013 at 10:15 pm

Those countries in Europe that are under the Eurozone are the ones who are badly hit by the euro crisis. The crisis doesn't only involve countries under Europe for it also affects countries from continents.

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