June 25th, 2014
from the Dallas Fed
The pace of global growth (excluding the U.S.) remained unchanged in first quarter 2014. Real gross domestic product (GDP) growth in both the advanced economies (ex. U.S.) and emerging economies maintained the same pace as in fourth quarter 2013. However, recent indicators of economic activity point to a slowdown in the advanced economies (ex. U.S.) and an acceleration in the emerging economies (Chart 1).
A stalled recovery in the euro area and the inability of Japan to restore its long-term growth potential are the biggest risks to advanced-economy growth. Recent actions of the European Central Bank (ECB) aim to jump-start the euro-area economy, but Japan has made limited progress in implementing structural reforms. Emerging economies slowed in the first quarter but saw conditions improve in April and May, driven primarily by a rebound in China.
Stimulus Targets Bank Lending in Euro Area
First-quarter real GDP growth edged down to 0.2 percent (quarter over quarter) in the euro area, falling short of the previous quarter’s pace of 0.3 percent. Tepid growth has prevented inflationary pressures from building. Headline consumer price index inflation dropped to 0.5 percent (year over year) in May from an already low 0.7 percent in April. Previously concentrated in the periphery economies, falling prices have become more broad based. The inflation rate in Germany declined to 0.9 percent (year over year) in May from 1.3 percent in April. The periphery economies must undergo internal devaluation to restore competitiveness under a fixed exchange rate, and low inflation in the core economies is making this much more difficult.
Weak domestic demand is a large restraint to stronger growth in the euro area. A pickup in business investment would improve employment conditions and restore consumer demand, but tight credit conditions are deterring business investment. An increase in loan demand in the euro area has not been matched by expansion in the credit supply (Chart 2).
On June 5, the ECB announced it would increase monetary accommodation to support lending to the nonfinancial private sector. The new stimulus measures include a negative deposit facility rate—a charge on banks to hold reserves—and targeted long-term refinancing operations that will allow banks to borrow up to three times the amount loaned to the nonfinancial private sector (excluding household mortgage loans).
The excess liquidity generated from these measures will contribute to a weaker euro. The weaker euro will promote an export-led growth strategy and build inflationary pressures through import price inflation. However, ultimately, domestic demand must be restored to ensure a sustainable recovery.
Temporary Factors Provide Boost to Japanese Economy
Economic Activity Picks Up in China; House Prices FallJapan’s accelerated growth in the first quarter was driven by temporary factors (Chart 3). The increase in private consumption was due to front-loading ahead of an April 1 consumption tax hike. For long-term growth to be sustained, structural reforms will be necessary. Political barriers have prevented these reforms from being implemented. As a result, high corporate taxes, a regulated labor market and inefficient capital allocation continue to dissuade private investment.
China’s economy grew 7.4 percent in the first quarter, down slightly from the 7.7 percent rate seen in fourth quarter 2013. Contributing to the deceleration was a larger-than-usual drop in exports, which primarily resulted from over-invoicing from the previous year. The exaggerated export data reflect efforts to circumvent capital controls and disguise capital inflows ahead of an anticipated currency appreciation.
However, economic activity has started to pick up in China following somewhat sluggish real GDP growth in the first quarter. The official Purchasing Managers Index new-orders index increased to 52.3 in May from 51.2 percent in April after hovering around 50 for the first three months of the year. Exports also recovered in May, growing 6.5 percent (year over year) and ending three consecutive months of declines.
Though the possibility of a widespread financial crisis remains low based on China’s past success of containing the failures of large financial institutions, expanding the state-owned banking sector would derail current attempts to adopt a more market-oriented growth strategy.As a result of falling house prices, property investment—which has historically provided a large boost to GDP—declined during the first quarter. The drop in real estate investment has led to a decline in new residential construction (Chart 4); however, falling house prices should eventually help stimulate demand and revive real estate investment. Further deterioration of China’s real estate market will threaten the solvency of China’s local governments and the stability of its shadow-banking sector.
- Internal devaluation is when a country, in lieu of a currency devaluation, decreases wages and increases productivity to make exports more competitive.
About the Author
Adrienne Mack is a senior research analyst in the Globalization and Monetary Policy Institute at the Federal Reserve Bank of Dallas.