The Global Economic Slowdown: Slow and Steady Wins the Race

By Hunter Bosson ’18

IMF Managing Director Christine Lagarde arrives at a news conference in TokyoThe IMF is scheduled to release its much-anticipated global economic forecast next Tuesday, and the news does not look good. Already gloomy predictions of advanced economies’ potential growth is already being complemented by skepticism of increasingly sluggish emerging economies. The worldwide economic slowdown has even prompted IMF Managing Director Christine Lagarde to warn, “Today what we must do is avoid that [the] new mediocre becomes the ‘new reality.’” But the focus on long-run growth is becoming increasingly dangerous.

Certainly economic growth was doomed to decline following the Great Recession. The drop in investment compounded the problems of aging demographics faced by many of the world’s advanced economies. This is why potential annual growth, the maximum annual growth a country can experience without suffering, is projected to be a third of what it was from 2001 to 2007. Slowed growth was to be expected by developed economies; their contractions were the deepest. The worry inspired from the IMF now is that the trend has gone global: major emerging markets like Brazil and Russia are predicted to have drastically reduced growth in future years. Government debt and too small of a capital stock are reducing the prospects for future living standards worldwide. Economic slowdown is not disadvantageous for everyone; China’s projected reduced growth will help its economy by avoiding overheating. But even after years of expansionary monetary policy around the world, economies continue to atrophy.

In fact, so much cheap money may be causing more problems than it solves. While the IMF continues to endorse expansionary fiscal and monetary policies, even Lagarde warned that low, and even negative, interest rates “foster a higher risk tolerance on the part of investors, which can lead to overpricing.” Risk-taking has already reached near-2006 levels, according to José Viñals of the IMF, with sovereign bond markets driven to particular excesses. Viñals worried as early as 2014 that a major market shock could lead to a financial panic, a near inevitability so long as Greece plays chicken with the Euro and Abenomics fizzles out. The banking sector is better regulated today than in 2006, but there remains a horde of unregulated shadow banks whose structural integrity is less certain. Financial crises do not have to come from the exact same place every time.

Tossing money into a liquidity trap by definition will have negligible effects, something to which the heads of many central banks can attest. Therefore it is with a grain of salt that we should take the IMF’s recommendation that central banks keep printing money and governments spend as much as their budgets will allow. Long-run economic stagnation is daunting, but if policymakers push the world economy too far, we may not recover from the next great meltdown.

Sources:

http://www.independent.co.uk/news/business/news/imf-fears-global-economy-is-suffering-secular-stagnation-10161154.html

http://www.economist.com/news/finance-and-economics/21648042-diminished-hopes

http://www.wsj.com/articles/global-economy-risks-long-period-of-low-growth-and-high-joblessness-imfs-lagarde-warns-1428591332

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