From time to time, Morningstar publishes articles from third party contributors under our "Perspectives" banner. In this instalment, Douglas McWilliams, CEO for the Centre for Economics and Business Research, outlines his world growth forecasts and recommendations for the leaders of the G20.
Summary: World economic growth in 2H 2012 is likely to be c.1%. Prices will be falling in 2H compared with 1H. We are not kneejerk supporters of a fiscal boost but the G20 now needs to act together to prevent deflation.
We are not long term fans of Gordon Brown, who has not received the blame he deserves for the UK’s current economic problems. But he got some things right. As Chancellor he kept the UK out of the euro, which today looks a pretty good call. And in 2008 he encouraged the authorities around the world boost demand by fiscal and monetary means which meant that although the 2009 recession was deep, it was fairly short-lived.
Today the world economy is again slowing sharply. The US and China are grinding to a halt. Europe is already in recession and growth is still falling. We estimate that world GDP in 2H 2012 could be up only 1% year on year. If this leads to an inventory the world will be in recession in the early part of 2012 for only the second time since 1945. At the same time falling commodity prices means that inflation is likely to drop sharply and could go negative in countries with strong currencies.
The monetary boosts that helped the world economy early in the year have lost momentum. The Chinese have cut interest rates and relaxed lending curbs, the US a resumption of Operation Twist (after a 4 month period with a sharp monetary slowdown), the ECB a cut in interest rates and the UK has announced the Extended Collateral Term Repo Facility as well as additional quantitative easing. These measures will probably help on balance but are they enough?
Cebr has never been averse to advocating Keynesian measures when the conditions are appropriate. We set these out in 2008 when we proposed a VAT cut which the government then implemented: 1) There has to be a risk of a deflationary spiral; 2) The measures themselves have to be temporary and reversible; 3) The measures should have some benefit in themselves rather than funding, for example, more health and safety officials; and 4) Confidence and expectations have to be such that monetary measures alone are unlikely to be successful at stimulating economies.
To these we would now add a fifth condition. Most of the countries that might benefit from a stimulus are too small and/or too indebted to do so on their own. The leakages would mean that the boost to demand for an individual country would be offset by the hit that their borrowing would take from the bond market. These conditions apply to everyone except the US, China, Germany and possibly Japan.
Any stimulus would therefore have to be matched across the G20. Our modelling suggests that if each G20 economy were to boost demand fiscally by 1% of GDP in the next six months, their debt would rise by only 0.16% of GDP and their GDP would rise by 0.8% (this compares with a debt increase of 0.7% and a GDP increase of only 0.3% if, say, the UK were to act on its own). The leakages would be largely offset by the gains from the GDP boost in the other economies and the spill-over benefits from their reflationary actions. The best form of action would be tax cuts, to be paid for over time by better economies in spending. The right time is now – the longer a deflationary spiral has to bed in, the greater the amount of ammunition necessary to deal with it.
Britain is probably too small to play a role in negotiating this. No European leader is in a strong position to take the initiative, because of the horrific euro crisis – which still shows no sign of abating. So this has to be a deal between the US and the Chinese in the first instance….
Chinese governments for historic reasons are very unwilling to be seen to be following a lead from Western economies. But if the Chinese made a suggestion – could the West respond with matching action? Perhaps there is a role for Gordon Brown after all?
The views contained herein are those of the author(s) and not necessarily those of Morningstar.
