The great policy experiment

The massive US stimulus package involves potential risks for the global economy

7 April 2021 Janet Henry, Global Chief Economist

    A synchronised global economic recovery is underway with a meaningful GDP rebound expected in all major countries this year. However, beneath the surface, the picture is bumpier. Quarterly growth rates will be erratic, varying enormously between economies and within them.

    Much will depend on access to vaccines and the pace of roll-out, how quickly governments ease their restrictions, whether households spend their accumulated savings, and the scale of stimulus programmes.

    The world will also be influenced by the great experiment that has begun in the US. The Biden administration has embarked on a fiscal stimulus unprecedented in peacetime. The USD1.9 trillion package is nearly 9 per cent of GDP, including about USD400 billion direct payments to households. It follows last December’s stimulus and, if President Biden gets his way, it won’t be the last.

    The latest package is skewed toward lower earners, who will likely spend a larger share of the payments than higher earners who have built up the biggest stock of savings over the past year.

    Backed by a commitment by the US Federal Reserve that it will be very patient about waiting for signs of sustained inflation before tightening policy, this policy combination could be very effective at supporting US and global growth – but it might prove to be a big mistake.

    US growth in 2021 should exceed other advanced economies’ and also significantly outpace most emerging countries except mainland China and India. But boosting near-term demand risks overheating the economy, and with higher oil and commodity prices, inflation is still the main concern
    The US consumer price inflation rate is set to bounce higher – it could approach 4 per cent by May. Eurozone inflation is forecast to exceed 2 per cent by year-end but, like the US rate, should fall below 2 per cent in 2022.

    But how will central banks respond if it doesn’t? Or if markets start to fear it won’t?

    Already some emerging economies are raising interest rates – notably Turkey, Russia and Brazil – and others are sounding hawkish.

    The US Federal Reserve has a new monetary framework – average-inflation targeting – and says it will wait to see if higher inflation is sustained before raising rates. Interest rate rises are still a long way off, but as long as vaccine roll-outs are proceeding well and economic growth accelerates, we expect the Fed to slow its asset purchases by end 2021.

    Markets are nervous though. Loose monetary policy has supported high asset price inflation so high inflation could turn market volatility into a full-blown ‘taper tantrum’ hitting risky asset prices, especially in emerging markets, potentially exposing financial stability vulnerabilities. This could even thwart the Fed’s aim to scale back the policy support.

    Financial stability risks are already concerning some emerging economies, notably mainland China, the first major country to halt monetary easing amid worries about excessive risk-taking in the financial system.

    The vulnerabilities are growing in many places, though. The longer aggressive monetary support continues, the greater the risk that leveraged households and companies, and the stretched asset valuations, could become destabilising.

    So the outlook, and therefore our forecasts, are uncertain. The main upside risk to global growth is an unexpectedly rapid drawdown of the savings accumulated over the past year. Downside risks are the pandemic itself, and premature tightening of financial conditions.

    But on the assumption of ongoing vaccination roll-outs and a steady re-opening of economies worldwide, we have raised our global growth forecasts to 5.6 per cent this year and 4.1 per cent in 2022. This year’s biggest upgrades are to the US, Canada and UK, while the largest downgrades are to the Eurozone and the South-east Asian ASEAN countries.

    First published 24 March 2021.

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    Disclosure and disclaimer

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