Economy is ‘uncertain, uneven and underwhelming’

IMF growth forecast
IMF growth forecast

Craig Wright, chief economist at Royal Bank of Canada, admits he is slightly more optimistic than the consensus in his economic outlook. Yet he acknowledges that the economic recovery is “uncertain, uneven and underwhelming.”

Uncertainty, on an almost daily basis, was evidenced by the volatility of the financial markets early this year. Speaking at RBC’s “2016 Global Economic Outlook” forum in January, Wright said, “It is almost as if the world is too small and all of the world’s problems become everyone’s problems.”

There is a danger that the fear in the markets is overtaking the economic fundamentals, and if it persists, the fear could become self-fulfilling.

Meanwhile, the uneven nature of the global economy is best illustrated by the impact of low oil prices on oil exporters and importers.

Overall global economic growth, says Wright, will be underwhelming: “A new normal” or “secular stagnation” that will determine “a slower speed limit for growth in the major economies around the globe.”

The speed of the economy’s growth is determined by labor force growth and productivity. Labor force growth is stalling and even declining in some advanced economies that have aging societies. This puts more pressure on productivity to offset the decline.

Craig Wright
Craig Wright

“Unfortunately, the longer we see weakness to global growth, that does weigh on productivity on a long-term basis.” This means 2 percent normal growth, or if inflation is added, 4 percent nominal growth “is the new growth story,” Wright says.

However, it is not all bad news. There will be some acceleration from the impact of monetary easing and less drag from fiscal tightening.

In the Eurozone, for example, “the crisis story is over,” Wright says.

Interest-rate cuts into negative territory by the European Central Bank and actions by policymakers have ensured that growth is starting to pick up, unemployment rates are falling, banks are rebuilding and credit extension is improving.

Five consecutive growth quarters in Europe were also no longer solely reliant on Germany, but based on more widely dispersed economic growth in all member states.

Policymakers in Europe followed a different strategy after the financial crisis. While the United States was not concerned about government debt and aimed at growth rather than fiscal measures, the ECB focused on austerity measures first and only later on supporting the economy with monetary easing.

As a result, the unemployment rate in Europe is still twice as high in Europe as in the U.S. and the U.K.

Growth in the U.K. and the U.S., on the other hand, is driven by consumers as the trade cycle continues to be weak.

In the United States in particular, consumer spending accounts for 65 percent of the gross domestic product and thus is carrying the load.

Wright notes that the consumer debt income ratio has come down dramatically, confidence outside of the financial markets is high, and housing has started to pick up.

He is even bullish on China. Yes, there is a great deal we don’t know about Chinese data, and there are legitimate concerns that the world’s second-largest economy will struggle to rebalance its export-led economy to a more consumer spending-based one, but policymakers have a number of tools at their disposal that they are willing to use: interest rate relief, reserve requirement cuts, and currency and fiscal policy initiatives.

“The concern is policymakers may not be able to juggle all of these balls,” Wright says. “We think they have been successful at that.”

The Chinese economy, which is growing at 6.5 percent, now represents 15 percent of the global economy. Together with the U.S. economy expanding at a rate of 2.5 percent and accounting for 20 percent of the global economy, the two countries will generate half of global growth in the future.

Global economic growth is in line with the forecasts by the IMF, Wright believes, which revised its figures for 2016 in January. The IMF expects slightly faster growth than last year even if the Chinese economy continues to slow, as growth will accelerate in the European Union, which as a common market is the largest economy in the world and double the size of China.

IMF growth numbers are almost identical to those of previous years, says Wright, because the growth story is still the same: low interest rates, accommodative monetary policy, fiscal policy less of a drag on growth, and oil prices.

“We should see global growth pick up as we move forward,” he says.

Although the price of oil is another risk scenario that is often seen negatively, Wright notes, 80 percent of the global economy actually benefits from lower oil prices buoyed by oversupply.

Notwithstanding that, he argues, the best cure for low oil prices is low oil prices and demand should pick up. He predicts that the price of oil will average $40 this year and end 2016 on a $50 high.

Wright believes the current volatility in the financial markets will continue, but that the activity there is uncoupled from the economic fundamentals because market participants generally overestimate the effect of the legitimate concerns that exist.

“I do think there’s a bit of crisis extrapolation going on,” he says. “Many people missed the depth and breadth of the last great recession.” Because nobody wants to miss the next one, they use data from the financial crisis to create worst case scenarios, he says.

In the Eurozone, for example, “the crisis story is over,” White says.