Vol 13 (2016) - Issue 2

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Growth Forecast: Moderate at Best

Global dynamics
Global growth should average in the low 3% real rate for the next 3-4 years. This is a slowdown from the 3.6% long-term average and noticeably slower that the close to 4% average growth rate in the decade prior to the Great Recession. At least three factors contribute to this less sanguine outlook: 1) the legacy of the Great Recession; 2) the restructuring of emerging market (EM) economies, China in particular; and 3) low commodity prices triggering re-balancing. We would also add the diminishing marginal effect of QE monetary policy and the continuing absence of counter-cyclical fiscal policy. In terms of regional leads and lags, developed economies (DM), the US in particular, will continue to lead, while commodity exporters will lag as a meaningful pick-up in commodity prices is unlikely during this time frame.

Great Recession legacy
The legacy of the Great Recession yielded a permanent loss of output, low inflation and high debt levels. A financial crisis depresses both aggregate demand and aggregate supply. The loss of output is permanent, unlike in a recession when the loss of output is temporary. In some instances (e.g., Sweden following the early-1990s banking crisis), the economy’s growth rate re-attains its pre-crisis pace. The Great Recession produced the worst outcome, with the combination of a permanent loss of output and a slowdown in the trend growth rate of the economy. The effect of the loss of output, low inflation and high debt levels lingers, as the rise in the stock of debt and ensuing period of deleveraging reinforce slower growth, low inflation and low interest rates.
Illustratively, China’s massive stimulus program in the aftermath of the 2008 crisis boosted credit growth and spurred investment in housing and infrastructure. But the ‘global growth baton’ could not be passed on to DM economies, as they were deleveraging (US and UK) or in the midst of a sovereign debt crisis (Euro area). Slower global growth ensued and led to overcapacity in certain sectors in China and deflation in the manufacturing sector, which increased the urgency to shift the growth model. The shift, in turn, implied slower growth in nominal GDP, which is a major headwind to deleveraging (Exhibit 1).