The IMF World Economic Outlook was released today. And it does not make for a particularly cheerful read. As Ed Conway points out in his excellent summary of the key points, the growth forecasts for the world as a whole have been revised down from 4.3% to 4% this year and 4.5% to 4% next year. Advanced economies are only expected to grow at 1.6% this year, revised down from the previous forecast of 2.2%.
And the main reasons for these revisions?
1) Increased commodity prices, in particular the impact of geo-political tensions on oil prices2) Sluggish growth in the US, as the private sector fails to take up the slack from the public sector3) Continuing sclerosis as the Euro area debt crisis fails to abate4) Supply chain impacts of the Japanese earthquake5) Contractionary policy to avoid overheating in emerging economies
But is slow growth really something we should be surprised by?
Although some of the reasons for a downward-revision in expectations (such as the Japanese earthquake) are unique to this recession, high levels of debt and the need for deleveraging are clearly acting as a drag on growth in the US and Europe. But this is to be expected following a debt-induced financial crisis. Especially when extremely high levels of debt reduce creditors' confidence in a sovreign's ability to pay this debt down.
As today's Buttonwood blog in the Economist points out, Reinhart and Rogoff's oft-quoted paper Growth in a Time of Debt makes clear, high levels of public (and private) debt – which are defined as over 85-90% – can have a detrimental impact on the growth rates of an economy. Unfortunately, as Buttonwood notes:
in terms of gross debt to GDP, all the G7 countries bar Germany are already above the 85% threshold, along with Belgium and, of course Greece and Portugal.
Based on this it is entirely rational that countries are looking to deleverage. But – and this is a major but – as this paper by McKinsey points out most episodes of deleveraging are coupled with a period of weaker GDP growth. What is more, in the past, when countries have tried to pay down their debt it has not usually been a multilateral event. This meant that deleveraging countries often saw a boost to GDP growth from net exports even as domestic consumption and investment were subdued.
Buttonwood highlights another paper by Cecchetti, Mohanty and Zampolli, which sums up the problem:
There is a vicious circle to this process since growth is the best way of getting out of a debt trap but the bigger the debts, the harder it is to grow.
As governments and households around the world try to rein in their debt this will inevitably act as a drag on growth. The IMF's outlook for weak growth in advanced economies does indeed seem to be the most likely outcome.