The world economy may have avoided another US-led financial crisis after the 2008 meltdown, but it is still facing a prolonged period of slow growth, which will have similar, if not worse consequences, especially for emerging economies like the Philippines.
According to the International Monetary Fund, global growth remains in low gear, averaging only 2.5 percent during the first half of 2013, which is about the same pace as in the second half of 2012. The advanced economies have recently gained some speed, while the emerging market economies have slowed down.
However, the IMF notes that emerging market economies continue to account for the bulk of global growth. Within each group, however, there are still broad differences in growth and position in the cycle.
There is strengthening conviction that China will grow more slowly over the medium term than in the recent past—previous expectations that the Chinese authorities would react with a strong stimulus if output growth were to decline toward the government target of 7.5 percent have had to be revised.
Changed perceptions have already provided a sort of mini stress test for financial systems. In emerging markets, the spillovers interacted with existing vulnerabilities and triggered both desirable and undesirable adjustments.
The desirable adjustments feature reallocated capital growing competitiveness problems: typically, the currencies that depreciated most were those assessed as overvalued. At the same time, however, volatility has gone up, and the risk of overshooting could weigh on investment and growth.
Looking ahead, global activity is expected to strengthen moderately but the risks to the forecast remain to the downside. The impulse is projected to come from the advanced economies, where output is expected to expand at a pace of about 2 percent in 2014, about 0.75 percentage point more than in 2013.
Growth will be driven by the reduction in fiscal tightening (except in Japan), and highly accommodative monetary conditions as growth. In the euro area, growth will be held back by the very weak economies in the periphery.
Emerging market and developing economies are projected to expand by about 5 percent in 2014, as fiscal policy is forecast to stay broadly neutral and real interest rates to remain relatively low. Unemployment will remain unacceptably high in many advanced economies as well as in various emerging market economies, notably those in the Middle East and North Africa.
Some new downside risks have come to the fore, while old risks largely remain. Beyond immediate risks, the prospect of reduced monetary accommodation in the United States may cause additional market adjustments and expose areas of financial excess and systemic vulnerability. In this setting, emerging market economies may face exchange rate and financial market overshooting as they also cope with weaker economic outlooks and rising domestic vulnerabilities; some could even face severe balance of payments disruptions.
In the euro area, risks continue to flow from the unfinished business of restoring bank health and credit transmission and from corporate debt overhang. Insufficient fiscal consolidation and structural reforms in Japan could trigger serious downside risks, especially of the fiscal variety.
Large public debt stocks and the absence of medium-term adjustment plans with concrete measures and strong entitlement reforms in key advanced economies, notably Japan and the United States, combine to keep fiscal risks at a stubbornly high level.
Fiscal vulnerabilities are also building in emerging market and low-income economies to varying degrees. In the meantime, geopolitical risks have returned.
Besides new cliff events, a growing worry is a prolonged period of sluggish global growth. A plausible downside scenario for the medium term would be characterized by a continuation of modest growth in the euro area because of persistent financial fragmentation and unexpectedly high legacy effects from private indebtedness, a hobbling of emerging market economies by imbalances and supply side bottlenecks and prolonged deflation in Japan.
Meanwhile, the end of US quantitative easing could come with a greater and longer lasting tightening of global financial conditions than is presently expected. As a result, the global economy could grow by only slightly more than 3% a year over the medium term, instead of reaccelerating to over 4%. What is more worrisome, monetary policy in the advanced economies could be stuck at the zero interest bound for many years. Over time, worrisomely high public debt in all major advanced economies and persistent financial fragmentation in the euro area could trigger new crises.
Forestalling the plausible downside scenario or the advent of new crises requires further policy efforts, mainly in the advanced economies. Old challenges to be addressed include repairing financial systems and adopting a banking union in the euro area and developing and implementing strong plans, supported by concrete measures, for medium-term fiscal adjustment and entitlement reform in Japan and the United States.
Furthermore, in the euro area and Japan, in particular, there is a need to boost potential output, including through reforms that level the playing field between insiders and outsiders in labor markets and ease barriers to entry into product and services markets.
A new challenge is for US monetary policy to change tack carefully in response to changing growth, inflation, and financial stability prospects. Excessive tightening may be difficult to undo, and global growth may well fall short of, rather than exceed, medium-term growth and inflation projections.