- Global monetary and fiscal policy effective in stemming the economic and financial crisis
- Strong rebound of emerging market economies suggests continued fiscal and monetary stimulus could be detrimental, leading to the risk of inflation problems or asset price excesses
- Industrialized world will see slower recovery than in the past and faces considerable challenges, including enormous fiscal deficits and timing the future rebalancing of monetary policy
- Canada and U.S. should see economic growth of close to 3% in 2010 and 2011
TORONTO, March 18 /CNW/ - The extraordinary measures taken to revive the global economy have achieved their primary purpose, but they have set the stage for new challenges that will constrain the pace of economic expansion, according to a new report from TD Economics.
"Initially, central banks and governments responded to the financial crisis like a trauma team - the goal was economic resuscitation and stabilization," says Craig Alexander, Deputy Chief Economist for TD Bank Financial Group. "The dramatic and coordinated monetary and fiscal stimulus had the desired effect. While it couldn't prevent the economic contraction, the policy response did blunt how deep the recession became and it laid the foundation for recovery."
Emerging markets face risk of inflation
However, the recovery scenario in developed countries looks very different from that in the developing world. The emerging markets of non-Japan Asia and Latin America were less directly affected by the financial crisis and recession - most of their weakness resulted from exposure to others through trade and finance. Once financial conditions stabilized and the decline in global demand slowed, production rebounded in these regions. Moreover, commodity-endowed emerging market economies experienced a considerable improvement in the value of their exports when commodity prices rallied. As a result, emerging markets are likely to be a primary driver of global economic growth in 2010 and 2011. However, Craig Alexander cautions that "the fiscal and monetary stimulus that has been provided around the world is no longer appropriate for many emerging market economies. A key theme over the next two years will be the need for these countries, such as China, to reduce the level of stimulus and lean against the rate of economic expansion in order to avoid the risk of inflation or asset price excesses."
Enormous fiscal deficits in developed world call for careful rebalancing
The story is very different for advanced economies, where the recovery is proceeding at a slower pace than is typically the case. Troubling is the fact that the policy prescription has created its own set of problems, with the dominant challenge being enormous fiscal deficits in Europe, the United States and Japan. The diminishing impact of fiscal stimulus will start to be a drag on economic growth in many countries starting in 2011. This will occur even without any formal tightening of fiscal policy to address the deficits. While private sector demand should steadily improve as the economic recoveries gain traction, the most likely scenario is that economic growth will remain moderate as governments start to address their fiscal deficits in 2011 and beyond. "The rebalancing in monetary policy must also be done carefully," says Alexander. "Raising interest rates too quickly will cause the recovery to lose momentum. On the other hand, raising them too slowly will create inflation risks. And either scenario would give rise to market volatility."
Implications for Canada and the U.S.
The economies of Canada and the U.S. are expected to experience growth of close to 3% in 2010 and 2011. While this is not terrible, it suggests a slower recovery compared with many past business cycles.
In the U.S., real estate will remain weak and consumer-spending growth will be constrained; it will take a long time to deleverage personal finances and the financial system. In Canada, the forces contributing to the slower recovery include limited growth in U.S. demand for Canadian exports, the strong Canadian dollar, a cooling of the Canadian real estate market and constrained growth in consumer spending brought about by high indebtedness.
Adding to these limits on growth will be the eventual rebalancing of fiscal policy. The amount of monetary policy stimulus will also be eventually scaled back. The Bank of Canada is expected to begin raising rates gradually in July, while the U.S. Federal Reserve is not expected to start tightening until early 2011. "The main theme is that the U.S. and Canadian economies have been resuscitated, but they will be convalescing for some time," notes Alexander. "We would be remiss to ignore the fact that there are also concerns over the uncertainty of financial system reform. It's clear to everyone that the world's financial system is in need of reform and that to be effective, it needs to occur on a coordinated global basis," adds Alexander. "But there's a real risk of it being done in a piecemeal or excessive fashion or implemented on a nation-by-nation basis."
The key message is that the global recovery will be sustained, but risks abound. The TD Economics projections show strong economic growth in non-Japan Asia and Latin America, and moderate economic growth in Japan, Europe and North America in 2010 and 2011. However, the forecast figures belie the likely volatility that is to come in the monthly and quarterly economic data and financial markets. It also masks the incredible challenges facing monetary, fiscal and regulatory policy makers.
TD Economics' Quarterly Economic Forecast can be found at www.td.com/economics