Is Coordinated Policy Easing Still Appropriate?
Leaders of the G-20 countries recently agreed to “avoid any premature withdrawal of stimulus” in order to secure a “durable recovery.” Policy stimulus may be appropriate for many advanced economies, which probably will experience sluggish upturns due to further deleveraging, and we expect that most major central banks will maintain their respective policy rates at extremely low levels through much of next year. However, bona fide recoveries appear to be taking hold in many parts of the developing world, and it is no longer apparent that continued policy accommodation remains in the best long-run economic interests of many of these countries.
Consider Brazil, for example. Although the Brazilian inflation rate has trended lower since the end of last year, we project that it will begin to rise again in mid-2010 as growth strengthens and commodity prices trend higher. With budding inflationary pressures, continued policy accommodation would not be appropriate. The Reserve Bank of Australia recently surprised most investors by hiking its main policy rate by 25 bps, and central banks in many developing countries will likely begin their own tightening cycles early next year as well. We do not mean to imply that developing countries will slam on the brakes, thereby threatening to derail the incipient global recovery. Inflation is generally benign at present, and there is no need for excessive tightening. However, policy will need to become less accommodative in many developing countries or inflation could become a major problem again.
Policy Priorities Beginning to Shift in Some Countries
When the global economy fell off a cliff last autumn, governments in most major economies were quick to enact stimulus programs, both monetary and fiscal, to prevent a total worldwide collapse in economic activity. Their efforts largely succeeded. Although the global economy has suffered its deepest recession in decades, a catastrophe (i.e., another Great Depression) was averted. Indeed, recent monthly indicators suggest that a tentative global recovery is starting to take hold.
The leaders of the G-20 nations met recently in Pittsburgh and congratulated themselves on a job well done. They also pledged to “avoid any premature withdrawal of stimulus” in order to secure a “durable recovery.” It will be interesting to see whether that commitment actually remains in place in the quarters ahead. When the global economy is teetering at the precipice, it is relatively easy to get leaders to agree that stimulus is needed. Now that the immediate crisis has passed and policy priorities are starting to diverge somewhat, achieving consensus may be more difficult.
The group of countries most likely to require continued macroeconomic stimulus is the western economies. Financial systems in many western economies became very leveraged earlier this decade, and economic growth could continue to be held back by continued deleveraging. Although the worst is probably over for the Euro-zone, we project that real GDP growth in continental Europe will remain lackluster throughout most of next year (see the chart on the front page). Both the U.S. and U.K. economies will likely grow at a sluggish pace next year also. If stimulus is withdrawn prematurely, these economies could conceivably roll back into recession. (A “double dip” recession is not our forecast, however.)
In contrast, bona fide recoveries appear to be underway in many developing economies. (The major exception to this statement would be Eastern Europe, which was very highly geared and which subsequently plunged into deep recession.) For example, Chinese industrial production has returned to double-digit growth rates recently (see below). Although the emerging world surely would experience a renewed slowdown if a number of major economies were to slide back into recession, continued stimulus may no longer be appropriate for many developing economies. Addressing inflation could become a policy priority again for some of these countries.
Take Brazil, for example. The overall rate of CPI inflation in Brazil has trended lower since the end of 2008, and it likely will drift lower over the next few months. However, we project that it will begin to pick up again by mid-2010 as Brazilian economic growth strengthens and as commodity prices continue to grind higher. Will Brazilian authorities continue to sanction further stimulus if inflation threatens to head higher? Probably not. Some analysts look for the Brazilian central bank to hike rates early next year, and central banks in some other large developing countries probably will follow suit as well.
As recently shown by Australia, an advanced economy that is also a G-20 member, rate hikes in some countries could begin fairly soon. The Reserve Rank of Australia surprised most investors on October 6 when it lifted its main policy rate by 25 basis points. The Australian economy escaped relatively unscathed from last autumn's global financial crisis, and recoveries in many of the country's major trading partners in Asia will continue to boost the country's exports.
We do not mean to imply that developing countries will slam on the brakes, thereby threatening to derail the incipient global recovery. Inflation is generally benign at present, and there is no need for excessive tightening. Very low interest rates may no longer be appropriate in many parts of the developing world, and central banks in these countries likely will begin to withdraw excess stimulus well in order to ensure that inflation does not become a major problem again. As rates rise, central banks in these countries likely will resist some of the upward pressure on their currencies via exchange market intervention.
Wachovia Corporation
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