The OECD Interim Assessment indicates slightly higher, albeit still moderate world growth, and the report underscores a warning against a hollow recovery driven by monetary policy rather than fundamentals.
The Interim Economic Assessment for March reflected a slightly more positive outlook on growth prospects compared to the OECD’s Economic Outlook published in November 2014. Tailwinds in the form of lower oil prices and quantitative easing by the ECB has provided a welcome boost to economies, in particular in the Euro area.
However, risks abound. Abnormally low inflation has been persistent and similarly for interest rates, where some have even ventured into negative territory (examples include Switzerland and Denmark). Leverage and risk-taking are largely driven by liquidity injections and not strong, promising fundamentals as one could hope. The risk of inflation remaining below target for an extended period of time is significant.
Deflation aggravates the real burden of nominal debt, and makes adjustment of relative prices less flexible, as especially nominal wages are downwards sticky. Certain abnormal features currently witnessed, such as medium-term bonds sold at negative nominal rates suggest that incorrect pricing of risk is a huge issue.
Meanwhile, equity indices have broken past records repeatedly in past months. The compression of spreads should be a real cause for concern, but should not deter central banks from continuing their accommodative stance, according to the OECD, as long as efforts to implement fiscal, structural and monetary policies continue.
Labour markets have not yet recovered – the phrase “jobless recovery” captures the situation in several post-crisis economies, such as the US, where recovery is well under way, but unemployment is still an issue; or rather, employment is an issue. While the unemployment rate is ticking downwards, employment numbers have not mirrored this trend, suggesting that the decline in the unemployment rate comes from people retiring, giving up on finding work or in some other way dropping out of the workforce.
The interim economic projections have the Euro area and Japan growing slightly more than expected in November, whereas commodity-exporting countries like Brazil and Canada have seen their growth estimates revised downwards by a drastic 2 percentage points in the case of Brazil and a more moderate 0.4 for Canada.
Especially Brazil is further restrained by monetary and fiscal tightening as well as political uncertainty in the wake of the Petrobras scandal, although Finance Minister Levy has been tasked with getting Brazil back to growth.
As India has revised its past GDP data, and China’s rapid development is waning off, India is poised to surpass China in growth, with 7.7% against 7.0% in 2015. For India, focus lies in continuing implementation of structural reforms, whereas China needs to rebalance its real estate sector and adjust to lower commodity prices and a slower growth rate. Service sector liberalization could drive future GDP and job growth in China, as domestic demand picks up from exports.
The small, upward adjustments for the Euro area and Japan are motivated by the expectation that a lower oil price is going to give real household income a boost, and in turn improve consumer sentiment and demand.
Recent data on consumer confidence seems to confirm this outlook, as the figure hit its highest point in eight years for consumers in the Eurozone. Real depreciation of the euro against the US dollar (amounting to about 15% since June 2014) has lent a helping hand by making the Euro area more competitive as exports become relatively cheaper in dollar-terms. Since demand is still very weak, policy stimulus is still warranted and fiscal policy in the Eurozone is expected to be neutral as opposed to the austerity previously seen.
The cyclical recovery in the US will continue. Q1 growth has been subdued by severe weather in the Northeast, but a rebound is expected for the coming months. The appreciation of the US dollar has a harmful effect on net exports, however GDP growth should continue along its potential growth path. The combined effects of a lower oil price and dollar appreciation is likely to result in the Fed holding out a bit longer before raising interest rates.
In Japan, growth is expected to pick up after a stagnant 2014, although at a meagre pace. Implementing reforms as proposed in the 3rd arrow of Abenomics remains a difficult, but crucial priority, if Japan is going to get back on track.
One important goal for striking a new equilibrium of growth and inflation is for average nominal wages to start rising, to initiate expectations of further increases in the upcoming annual wage bargaining round. Japan’s public debt has surpassed 220% of GDP and counting, so the imperative of getting public spending and debt back to sustainable levels can hardly be overestimated.