Global Activity Has Picked Up, Largely Due to Advanced Economies

Econintersect: The G-20 meeting of Finance Ministers and Central Bank Governors is currently in progress in Sydney. The International Monetary Fund prepared a presentation on Global Prospects and Policy Challenges which is summarized after the “Read More”. Pictured below is Australian Treasurer Hockey with US Fed Chair Janet Yellen.

Executive Summary

Global activity has picked up, largely on account of advanced economies. Growth firmed in 2013H2, driven largely by stronger outturns in advanced economies as final demand expanded broadly as expected. In many emerging markets, despite a boost to output from stronger exports, domestic demand has been weaker than expected, reflecting in part tighter financial conditions.

A new bout of financial volatility has affected emerging market economies as markets reassess their fundamentals. While the pressures were relatively broad-based, emerging economies with relatively high inflation and high current account deficits saw the largest asset price declines initially. Markets are showing signs of stabilizing recently, although they are still fragile, on the back of actions by key emerging economies to shore up confidence and strengthen their policy commitments. This episode, however, underscores vulnerabilities and the challenging environment for many emerging economies. The rapid jump in global risk aversion had also driven down advanced economy equity prices.

The outlook remains broadly as projected in the January WEO, assuming that the impact of the recent financial volatility is short lived. In advanced economies, less fiscal consolidation and relaxed financial conditions will support growth this year, while near-term prospects for emerging economies are broadly unchanged. Thus, global growth is projected to increase to about 3¾ percent in 2014 (from 3 percent in 2013) and 4 percent in 2015, similar to the January 2014 WEO Update.

However, the recovery is still weak and significant downside risks remain. Capital outflows, higher interest rates, and sharp currency depreciation in emerging economies remain a key concern and a persistent tightening of financial conditions could undercut investment and growth in some countries given corporate vulnerabilities. A new risk stems from very low inflation in the euro area, where long-term inflation expectations might drift down, raising deflation risks in the event of a serious adverse shock to activity.

Further action and cooperation are needed to promote financial stability and robust recovery. Specifically:

• Advanced economies should avoid premature withdrawal of monetary accommodation as fiscal balances continue consolidating. Given still large output gaps, very low inflation, and ongoing fiscal consolidation, monetary policy should remain accommodative in advanced economies. There is scope for better cooperation on unwinding UMP, including through wider central bank discussions of exit plans. In the euro area, repairing bank balance sheets remains critical to monetary policy transmission. Finally, fiscal consolidation should proceed at a measured pace, while preserving the long-run growth potential of the economy.
• In emerging market economies, credible macroeconomic policies and frameworks, alongside exchange rate flexibility, are critical to weather turbulence. Further monetary policy tightening in the context of strengthened policy frameworks is necessary where inflation is still relatively high or where policy credibility has come into question. Priority should also be given to shoring up fiscal policy credibility where it is lacking; subsequently buffers should be built to provide space for counter-cyclical policy action. Exchange rate flexibility should continue to facilitate external adjustment, particularly where currencies are overvalued, while FX intervention—where reserves are adequate—can be used to smooth excessive volatility or prevent financial disruption.
• Further policy actions are needed to reduce unemployment and strengthen medium-term growth, while making it more balanced. Key policies to boost potential include competition-enhancing product market reforms, infrastructure investment, and labor participation reforms, while further action is needed to avoid a resurgence of global imbalances as the recovery proceeds and ensure sustainable medium-term growth.

[click on image below to read the entire IMF presentation]