Andrew Sentance: Prospects for global economic recovery
Speech by Mr Andrew Sentance, Member of the Monetary Policy Committee of the Bank of
England, at the British Chambers of Commerce Annual Convention, London, 18 March 2010.
* * *
I would like to thank Michael Hume and Abi Hughes for research assistance and I am also grateful for helpful
comments from other colleagues. The views expressed are my own and do not necessarily reflect those of the
Bank of England or other members of the Monetary Policy Committee.
Over the three-and-a-half years I have spent so far on the Monetary Policy Committee, one
of the things that has struck me most forcefully is the way in which the UK economy is so
heavily influenced by international developments. The global financial crisis and the
recession which resulted from it have highlighted that very clearly. But even before we felt
the full force of the crisis in late 2008 and early 2009, UK inflation was pushed up to over 5%
by a surge in global energy and commodity prices. And looking back over the whole history
of the MPC since 1997, most of the shocks to UK growth and inflation that the Committee
has had to worry about have had a significant international or global dimension.1
These global influences on the UK economy partly reflect our economic history. Flows of
overseas trade, investment and finance have played a major part in shaping the
development of the British economy, creating a highly international business and financial
environment here in the UK. But links to the global economy have also been strengthened by
globalisation, which has reinforced international linkages across the world economy as the
global economic system has become more integrated and interdependent.2
The performance of the global economy is therefore critical to the prospects for UK recovery.
And it is therefore very encouraging that the global economy has bounced back strongly
following the sharp contraction in output and trade in late 2008 and early 2009. As Chart 1
shows, the growth of world GDP in the second half of last year has returned to around its
prerecession growth rate and world trade has also bounced back strongly. This recovery in
the world economy appears to have continued into the early months of this year. For
example, the volume of international air traffic, which is highly sensitive to world growth
trends, was 6.4% up on a year ago in January 2010.3
Despite the gloomy headlines surrounding the release of the latest UK trade figures last
week, the UK economy is benefiting from this revival in world trade and activity. The latest
trade data show that since the second quarter of last year, the volume of UK goods exports,
excluding oil and erratics, have risen 8.5%.4 This is equivalent to an annual growth rate of
15% - around three times the trend rate of UK export growth since the early 1990s.5 But
imports have bounced back too, which is why the trade deficit is not shrinking at present. In
the short-term that should not be a source of concern - rising imports at this stage of the
cycle are usually a sign of a recovery in demand and a turnaround in the stock cycle. But
over time, we should see rising exports helping to close the UK's trade deficit. The very
positive responses on export orders and confidence shown by a range of recent business
surveys suggest that there is a significant further boost to our international trade performance
on the way - supported by the competitiveness benefits of sterling's depreciation since
mid-2007.
This bounceback in the world economy is much stronger than we might have expected a
year ago.6 So what has been driving it? And how resilient might it prove to be?
In my view, three main factors have been driving the recovery over the last year - a bounce
back in business and consumer confidence, strong growth in Asia and other emerging
markets, and the impact of policy stimulus. These three factors will also have a key bearing
on future global economic prospects, and I will discuss them briefly in turn.
Recovery in confidence
A key factor which plunged the world economy into recession was the massive shock to
business and consumer confidence across all the major economies of the world when the
global financial system appeared to be rocking and reeling in late 2008 and early 2009. Since
then, confidence has gradually recovered as the financial system has stabilised and the
shock waves from the traumatic events of eighteen months ago have subsided.
One indicator of this recovery in confidence is the performance of stock markets, reflecting
an improving assessment of business prospects. As Chart 2 shows, equity markets in the UK
and US have recovered by around 60% from their troughs about a year ago.
Alongside this improvement in financial market confidence, business survey indicators have
also been improving across the global economy. Chart 3 shows a composite measure of
surveys of purchasing managers from the major world economies. The very negative
readings of around a year ago have given way to responses which are consistent with rising
activity and the expectation of future growth.
The natural momentum of a recovery is that, as growth continues and memories of the
recession fade, both consumer and business confidence will continue to build. Over time,
cutbacks in investment by firms and the deferral of major consumer purchases will begin to
reverse. As a result, we should expect both consumer and investment demand to gradually
strengthen as long as new shocks to confidence do not emerge.
Growth in Asia and emerging markets
Alongside this general recovery in confidence, a key engine of the world recovery has been a
strong rebound in Asia and many other emerging market economies. As Chart 4 shows,
forecasts for growth this year and next in the major Asian markets - and in developing and
emerging market economies as a whole - are for a continuation of the healthy growth rates
seen in these economies throughout the past decade.
There are good grounds for believing that this strong performance in Asia and other
emerging markets will continue to be an engine of world economic growth as the recovery
continues. First, there are healthy supply-side fundamentals in the economies of Asia - a
large potential labour supply, with the region accounting for about half of the world's
population, and scope for continuing productivity catch-up with the more advanced
economies. Second, governments in Asia and many other emerging market economies
remain committed to market-oriented policies and continued integration into the world trading
system, which has proved an important underpinning for rapid growth and development in
the past.7 Third, public and private finances are generally in good shape. The banks and
other financial institutions in the major Asian economies were not directly affected by the
crisis in the same way as the financial sector in the US and Europe. Government finances
have also started from a stronger position, which means that fiscal policies can continue to
support private sector demand and there is much less need for serious fiscal retrenchment
as a result.
These strong demand and supply-side fundamentals help to mitigate concerns that the
impetus from Asia and emerging markets will quickly fizzle out, or that it will be undermined
by the re-emergence of global imbalances. And the increasing importance of Asia in the
world economy means it is now a material influence on the growth of the world economy. As
Chart 5 shows, the seven largest economies in the Asia-Pacific region, including India,
China, Japan and Australia, now account for close to a quarter of world GDP - not far short
of the contribution to world GDP from the United States and the European Union.
Indeed, there is a worry that growth in Asia and other emerging markets may prove too
strong, fuelling the growth of asset prices and putting upward pressure on global energy and
commodity prices. As Chart 6 shows - the strong growth in developing economies and
emerging markets in the mid-2000s was associated with significant upward pressure and
volatility of oil, food and metal prices.
Recent movements of the oil price have been very sensitive to news about the pace of global
growth, and commodity prices have picked up more generally as growth has returned to the
world economy. If the momentum of the global recovery is sustained, there is a risk of further
upward price pressure from this direction, with a knock-on impact on broader measures of
inflation around the world.
The role of economic policy
The third engine of growth in the world economy at present is the stimulus provided by a
range of policy measures. Economic policies have played a role in stabilising world economic
and financial conditions in three ways: first, by direct interventions to underpin the stability of
banks and the financial system more generally in many economies; second, through
stimulatory fiscal policies; and third, through supportive monetary policies - very low interest
rates and direct injections of money to support demand in a low interest rate climate, such as
the MPC's policy of "Quantitative Easing".
However, the current level of stimulus from monetary and fiscal policy was designed to turn
around economies in the wake of the traumas we experienced 12-18 months ago. As
confidence builds and private spending recovers, it is likely to be appropriate to gradually
withdraw at least some of this policy support for demand, without jeopardising growth
prospects.
The need to re-adjust economic policy is most obvious on the fiscal side, where deficits are
very high by historical standards, particularly in the US, Europe and Japan - as Chart 7
shows. These large deficits reflect the important role that public spending and tax policies
have played worldwide in stabilising economic conditions during the recession. But to ensure
sustainable public finances over the medium-term, these budget gaps will need to be closed
over the recovery.
In many countries, policy-makers are rightly concerned about the negative consequences for
demand of tightening fiscal policy too quickly and abruptly while the recovery is still fragile.
But a tightening of fiscal policy which is pursued as part of a longer-term, credible and well
worked-out plan is much less likely to have such negative demand-side effects, and may
have offsetting benefits for the supply-side performance of the economy.
Progress in putting public finances on a sounder footing can increase confidence and reduce
uncertainty about future economic prospects, providing a much better climate for a recovery
in private sector demand. It can also support the supply-side performance of the economy by
helping firms and individuals plan for the longer term. The effects of deficit reduction on
financial markets should also be positive for private sector demand. Long-term interest rates
are likely to be lower in a world in which government deficits are being reined in, and the risk
of destabilising financial market movements is also reduced. Again, this is likely to provide a
much better climate for private sector investment and long-term spending and planning more
generally.
An additional mechanism through which the negative demand-side consequences of fiscal
tightening can be offset is by maintaining a relatively loose or relaxed monetary policy. So
the other arm of withdrawing policy stimulus - a tightening of monetary policy - needs to take
into account the potential impact of deficit reductions on demand, activity and inflation. What
this implies for the monetary stance and the level of interest rates will inevitably vary between
countries and regions as different monetary authorities make their own judgements about the
pace and extent of tightening appropriate to their own circumstances. Indeed, some
monetary authorities in the Asia-Pacific region, where growth has been stronger and
inflationary worries greater, have already begun to tighten policy.
Elsewhere, in the UK and many other major economies, the current settings of monetary
policy still reflect the aggressive loosening of policy to counter the severe downside risks of
the recession a year ago. As these downside risks recede and recovery becomes more firmly
established, it will be important to reassess how much of that stimulus is still needed to keep
the economy on a steady course consistent with low inflation.
Conclusion
The turnaround in the global economy over the last year has been quite impressive, given
the scale of the shocks from the financial crisis. That should give us grounds for
encouragement that continued growth in the global economy will provide a supportive
backdrop for recovery in the UK - even if some of our important markets, such as the
economies of the euro area, may be turning around more slowly. Indeed, the IMF's
mediumterm forecasts for the world economy over the next five years point to stronger global growth
than we experienced in previous recoveries from the major recessions in the 1980s and
1990s, as Chart 8 shows.
But there are also many uncertainties affecting the current outlook for the global economy
and I would highlight four key influences which will shape the recovery which does unfold
over the next few years.
First, I have argued that an improvement in business and consumer confidence has been a
key ingredient in the economic turnaround so far. And in the absence of further shocks to the
global economic system, we should expect confidence among firms and households to
continue to recover, supporting the growth of private sector spending and helping the
recovery to build momentum. But given our experience in recent times, we cannot rule out
new shocks which could set back recovery.
Second, a major financial adjustment is taking place in the major economies of Europe and
the United States as banks adjust their lending behaviour and seek to rebuild their balance
sheets. This adjustment will continue to dampen the recovery in demand on both sides of the
Atlantic too some degree, though its impact should lessen as the process of financial repair
and rebuilding progresses.
Third, world growth in the recovery so far has been particularly strongly driven by the
performance of Asia and other emerging markets, and their dynamism has to a large extent
offset slower growth elsewhere. In my view this is not a flash in the pan, but a structural
feature of the world economy that we are now living in, and we should expect a continuing
impetus to global growth from this direction. However, as we saw in the mid-2000s, there is
also the associated risk of upward pressure on inflation from global energy and other
commodity prices, if the momentum of world growth becomes too strong.
Fourth, the high degree of stimulus provided by fiscal and monetary policy to combat the
recession will need to be withdrawn over a period of time. Returning budget deficits to a
more sustainable level will require a prolonged tightening of fiscal policy in many countries,
including the UK. Monetary policy can provide an offset by continuing to support the growth
of private spending - though the appropriate degree of monetary stimulus will need to be
continually reassessed in the light of the progress of the recovery at home and abroad and
its impact on inflationary pressures.
Given the turbulence we have seen in the major economies of the world over the last two
years, it is very natural to worry about setbacks to the recovery, both in the UK and overseas.
In the past, economic recoveries have not been smooth and linear. So we should expect to
see some variability in growth rates, both at home and abroad, as this recovery develops.
However, looking through this data volatility, there are also good grounds for expecting the
growth of the world economy to continue to provide a healthy support to the UK's economic
recovery over the years ahead. And, over time, that is likely to bring a different set of policy
challenges to the ones we have been facing over the course of the recession.