The dynamics that were emerging at the time of the October 2013 World Economic Outlook are becoming more visible. Put simply, the recovery is strengthening.
In our recent World Economic Outlook, we forecast world growth to be 3.6 percent this year and 3.9 percent next year, up from 3.0 percent last year.
In advanced economies, we forecast growth to reach 2.2 percent in 2014, up from 1.3 percent in 2013.
The recovery which was starting to take hold in October is becoming not only stronger, but also broader. The various brakes that hampered growth are being slowly loosened. Fiscal consolidation is slowing, and investors are less worried about debt sustainability. Banks are gradually becoming stronger. Although we are far short of a full recovery, the normalization of monetary policy—both conventional and unconventional—is now on the agenda.
Brakes are loosened at different paces however, and the recovery remains uneven.
It is strongest in the United States, where growth is forecast to be 2.8 percent in 2014.
It is also strong in the United Kingdom and Germany, where some imbalances persist, but where we forecast growth to be 2.9 percent and 1.7 percent respectively.
In Japan, where we forecast 1.4 percent growth in 2014, fiscal stimulus has played a large role, and the strength of the recovery depends on private demand taking the relay.
And, going back to the Euro area, the good news is that, for the first time in two years, Southern periphery countries are forecast to have positive, if admittedly still low, growth. But, while their exports are generally strong, internal demand is still weak, and it has to become stronger for the recovery to be sustained.
Emerging and developing economies continue to have strong growth, lower than before the crisis, but high nevertheless. We forecast their growth to reach 4.9 percent this year, slightly up from 4.7 percent last year. In particular, we forecast growth of 7.5 percent for China, and 5.4 percent for India. Of particular note is the performance of sub Saharan Africa, where we forecast growth of 5.4 percent.
These emerging and developing economies have to operate however in a changing world environment. Stronger growth in advanced economies implies increased demand for their exports. The normalization of monetary policy in the United States, however, implies tighter financial conditions and a tougher financial environment. Foreign investors are less forgiving, macroeconomic weaknesses are more costly. And financial bumps, such as those we saw last summer and earlier this year, may well happen again.
Acute risks have decreased, but risks have not disappeared.
Japan will need all three arrows if it is to both sustain growth and maintain fiscal sustainability. Adjustment and recovery in southern Euro countries cannot be taken for granted, especially if Euro area wide inflation remains very low or even, worse, turns to deflation, making the task of reestablishing competitiveness in the South even harder. As discussed in the Global Financial Stability Report, financial reform is incomplete, and the financial system remains at risk. Geopolitical risks have arisen, although they have not yet had global macroeconomic repercussions.
Looking ahead, the focus must increasingly turn to the supply side, and I want to make three points:
First, potential growth in many advanced economies is very low. This is bad on its own, but it also makes fiscal adjustment more difficult. In this context, measures to increase potential growth are becoming more important—from rethinking the shape of some labor market institutions, to increasing competition and productivity in a number of non-tradable sectors, to rethinking the size of the government, to reexamining the role of public investment.
Second, although the evidence is not yet clear, potential growth in many emerging market economies also appears to have decreased. In some countries, such as China, lower growth may be in part a desirable byproduct of more balanced growth. In others, there is clearly scope for some structural reforms to improve the outcome.
Finally, as the effects of the financial crisis slowly diminish, another trend may come to dominate the scene, namely rising inequality. Though inequality has always been perceived to be a central issue, until recently it was not seen as having major implications for macroeconomic developments. This belief is increasingly called into question. How inequality affects both the macroeconomy, and the design of macroeconomic policy, will likely be increasingly important items on our agenda for a long time to come.
This piece is cross-posted from iMFdirect with permission.