In Morgan Stanley’s Sunday Start note explaining “what’s next in global macro”, the firm’s go-head of economics, Chetan Ahya notes that he remains confused by a “unique cycle” in which “our current conversations would have been centred on whether the global economy is overheating. Instead, the probability of a global recession and possibility of further stimulus still dominate our discussions on the global economy.” Here is why, according the Morgan Stanley, the current cycle is so different, and why “global growth will likely remain below trend for a while longer and recession risks will likely remain a more topical subject than overheating risks.“
From Morgan Stanley’s Sunday Start | What’s Next in Global Macro, authored by Chetan Ahya
It’s Just Not What Used to Be
This cycle has been unique. Had it been a typical cycle, our current conversations would have been centred on whether the global economy is overheating. Instead, the probability of a global recession and possibility of further stimulus still dominate our discussions on the global economy.
The private sector’s behaviour and mind-set is the root cause of the uniqueness of the current cycle. Among the top 10 DM and top 10 EM economies, private sector debt in 12 of the 20 economies is above 200% of GDP. The shock from the financial crisis has left both the private sector and financial intermediaries seeking to restore health to their balance sheets. This motive has taken on paramount importance and might have even superseded the usual profit maximisation motive.
Reflecting the subdued animal spirits, the private sector has not responded to monetary stimulus with as much vigour as would have been expected. Moreover, monetary and fiscal policies have not really been employed in tandem in the past five years. Concerns that government spending tends to be less productive in nature and crowds out private spending, coupled with the issue that high levels of public debt would restrain longer-term economic growth prospects, have meant that public demand has not been a meaningful offset to weak private demand. The net result is a global economy which is still affected by the problem of demand deficiency and lowflation risks.
Japan’s experience over the past two decades is instructive in this regard. In the 1990s, fiscal policy was employed aggressively to lift aggregate demand, but deflationary pressures persisted as the monetary policy stance was too tight – real interest rates were too high relative to real GDP growth. The private sector repaired its balance sheets and built up its saving consistently during the 1990s before saving stabilised at relatively high levels during the early part of the current decade. The change in monetary policy stance came in 2013 when the BoJ brought real interest rates into negative territory. The complementary monetary and fiscal policies, at that time, led to an improvement in the GDP deflator, moving above 1%Y for the first time after 22 years, and a change in the private sector’s behaviour as it drew down its saving and levered up. However, policy-makers tightened fiscal policy prematurely in 2014, resulting in a renewed rise in private sector saving, which brought back the challenges of weak growth and disinflationary pressures.
The implications from Japan’s experience are two-fold: i) Both monetary and fiscal policies must be employed in order to fully address the demand deficiency – monetary policy to keep interest rates low and fiscal policy to provide a direct boost to aggregate demand; and ii) Expansionary policies should be maintained until the private sector is done repairing its balance sheet, when inflation expectations have stabilised, as any premature tightening would revive the challenges all over again. The recovery of private sector momentum is key to reviving productivity growth.
The private sector in major parts of the world has remained in a deleveraging mode, weighing on global growth. Private sector debt growth has been decelerating in the euro area, Japan and the UK but has been holding up reasonably well in the US. The softer momentum in private sector debt growth is also reflected from an expenditure perspective, where capex growth has been weak while consumption is holding up as the last pillar of growth. The deceleration in DM private demand momentum, coupled with an ongoing adjustment process in EM, has therefore meant that global growth has been close to the recession threshold of 2.5% for the last two quarters.
While we do project a recovery from 2Q16 onwards, the risks to the outlook remain skewed towards the downside. The momentum in private sector debt growth and the policy response which follows will be key in determining the growth outlook. In Japan, where private sector debt growth momentum has slipped the most among the G4 economies, policymakers have recently announced their intention to postpone the consumption tax hike, originally scheduled for 2017, and we expect them to announce material fiscal easing soon. Europe is already pursuing a moderately expansionary fiscal policy and the refugee crisis spending could provide a strong fiscal impulse relative to our baseline. In the UK, we expect only a mild increase in the fiscal deficit, but active fiscal policy will be needed if the recent weakness in private spending is sustained. In the US, private sector momentum has been relatively healthy and recent signs are pointing towards an uptick in consumer spending. We therefore do not expect a large fiscal response, but do expect that overall growth in 2016 is likely to remain sub-par due to the drag from the external environment. In China, policy-makers had lifted public spending to offset the weakness in private demand. However, they have begun to reduce policy support recently, resulting in a slowdown in growth, raising the risk of the current mini-cycle recovery ending early. Taken together, global growth will likely remain below trend for a while longer and recession risks will likely remain a more topical subject than overheating risks.
