Economists expected 2014 to be the year in which the global expansion stepped up a gear.
Instead, nearly five years into its recovery from a deep recession, the rich world’s economy still looks disappointingly weak. America’s GDP grew at an annualized rate of only 0.1 percent in the first quarter. Euro-area growth, at 0.8 percent, was only half the expected pace.
Some of the weakness is temporary (bad weather did not help the United States), and it is not ubiquitous: in Britain and Germany, for example, growth has accelerated, and Japan has put on a brief spurt. Most forecasters still expect the recovery to gain momentum during the year.
But there are reasons to worry. The stagnation in several big European countries, notably Italy and France, is becoming more entrenched. Thanks to a rise in its consumption tax in April, Japan’s growth rate is set to tumble, at least temporarily. America’s housing rebound has stalled. And across the rich world, yields on long-term government bonds, a barometer of investors’ expectations for growth and interest rates, have fallen sharply.
The yield on 10-year Treasuries, at 2.5 percent, is half a percentage point lower than it was at the end of 2013. Given that American expansions tend to be about five years long, the United States could find itself going into the next downturn without having had a decent upturn at all.
What should be done to forestall that outcome? The standard answer is that central banks need to loosen monetary conditions further and keep them loose for longer. In some places that is plainly true. The euro area’s weakness has a lot to do with the conservatism of the European Central Bank, which has long resisted the adoption of unconventional measures to loosen monetary policy, even as the region has slipped ever closer to deflation. Thankfully, it has signaled that it will take action at its next meeting in June.
But if loose monetary conditions are a prerequisite for a more vigorous recovery, it is increasingly clear that on their own they are not enough. Indeed, overreliance on central banks may be a big reason behind the present sluggishness. In recent years, monetary policy has been the rich world’s main, and often only, tool to support growth.
A hollow pledge
Fiscal policy has worked in the opposite direction: virtually all rich-world governments have been cutting their deficits, often at a rapid clip. Few have shown much appetite for the ambitious supply-side reforms that might raise productivity and induce firms to invest. Free-trade deals languish. The much-promised deepening of Europe’s single market, whether in digital commerce or services, remains a hollow pledge.
Against this unhelpful background, central banks have been remarkably successful. Growth has been so stable that economists are beginning to talk, somewhat eerily, of the return of the “Great Moderation,” the era of macroeconomic stability that preceded the global financial crisis. Sadly, with such stability at a subpar pace of growth, low interest rates and low volatility have a bigger impact on asset prices than on real investment, and risk creating financial bubbles long before economies reach full employment.
One way to address this risk is for central bankers to use regulatory tools to counter the buildup of asset-price excesses. This is particularly urgent in Britain, where the housing market is showing clear signs of froth. What is really needed, though, is a more balanced growth strategy that relies less exclusively on central banks.
Investing in infrastructure
Such a strategy would have two elements. One is to boost public investment in infrastructure. From American airports to German broadband coverage, much of the rich world’s infrastructure is inadequate. Borrowing at rock-bottom interest rates to improve it will support today’s growth, boost tomorrow’s and leave the recovery less dependent on private debt.
A second element ought to be a blitz of supply-side reforms. In addition to the obvious benefits of freer trade, every rich country has plenty of opportunities for reforms at home, from overhauling the regulations that inhibit homebuilding in Britain to revamping America’s ineffective system of worker training.
Progress on these fronts would lead to stronger, more stable growth and would reduce the odds that the next recession begins with interest rates close to zero (making it particularly hard to fight). But it demands politicians who can distinguish between budget profligacy and prudent borrowing, and who have the courage to push through unpopular reforms. The rich world needs such politicians to step up.
Copyright 2013 The Economist Newspaper Limited, London. All Rights Reserved. Reprinted with permission.