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A False Spring at the Spring Meetings?

WASHINGTON, DC – Every spring, international bureaucrats flock to Washington, DC, as reliably as swallows to Capistrano, for the annual meetings of the International Monetary Fund and the World Bank, where they exchange information about their local economies and policy prospects. Because these officials attend multiple events over the course of the week, an echo chamber develops, from which a general perception of the state of the global economy emerges. Policy making around the world is then influenced by that perception.

This time round, the sense was positive. According to IMF staff, as reported in their World Economic Outlook, real GDP should expand by about 2% in advanced economies this year and next. This will pull the unemployment rate below 6%, not much different from its level before the 2008 financial crisis. Deflation or unwelcome disinflation is now seen only in the rear view mirror, as consumer price inflation settles around 2%, the goal of most major central banks.

But, as any resident of New England knows, April showers do not always bring May flowers; sometimes they bring only more and colder showers. Not to rain on officials’ parade, but we fear that they are taking too much comfort in the stabilization of economic conditions. Beneath the headline numbers, there is little evidence that underlying problems have been resolved.

It wouldn’t be the first time. The post-1945 record includes two prior “lost decades” in which economies struggling to recover from severe financial crises – including about a dozen countries in Latin America from 1982 to 1992, and Japan from 1992 to 2007 – underperformed their own trend growth and that of their peers.

As bleak as this history seems, annual real GDP growth per capita was positive in 60% and 75% of those years, respectively, in Latin America and Japan. Indeed, real GDP per capita expanded by more than 2% in at least a quarter of those years. That is, these countries glimpsed rays of sunshine through what turned out in retrospect to be a mostly solid cloud cover.

Acceleration in economic activity may stir hope in officialdom, but levels matter, too. In Europe, real growth GDP has been only barely positive, on average, since the financial crisis, and its level in 2016 was about 20% below that predicted by the trend over the ten years up to 2007. This ranks as the slowest recovery from a severe financial crisis in two centuries. And aggregation hides a multitude of problems: Greece and Italy, for example, will not regain their pre-crisis level of real GDP per capita within the World Economic Outlook’s forecast period, which stretches to 2022.

Yes, post-crisis spending headwinds are an important impediment to growth, partly owing to their persistence. But central to economic performance over this period is stagnating growth in potential output. According to the IMF, growth in the advanced economies’ real potential GDP – think of this as the underlying trend for aggregate supply – has fallen by half this century, from 2.71% in 2001 to as low as 1.28% just a few years ago. The picture is bleaker in the US, where, according to the Congressional Budget Office the amplitude of the swing is double, from about 4% to 1.5%. But all of the G7 economies share this phenomenon, because their aging populations are growing more slowly, withdrawing from the labor market, and adding little extra output per additional hour worked.

Whether productivity, or output per hour, will continue to languish is hard to predict. But data are data, and they show quite clearly that productivity growth has been languid for some time.

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The growth of potential output is not just an economist’s abstraction. If, as seems to be the case, the expected path of income turns south, we will have fewer future resources to meet our needs. To the extent that we have consumed and borrowed now in anticipation of higher income, disappointment is in store.

There certainly is scope for disappointment in advanced economies, considering that gross general government debt is hovering around 106% of nominal GDP and fiscal deficits are stretching beyond the forecast horizon. The budget math only gets harder as central banks normalize monetary policy, even if interest rates do not return completely to their pre-crisis levels. In economies with a recent record of fiscal restraint, including Australia, Canada, and New Zealand, the private sector has been borrowing hand over fist. In times of distress, private-sector mistakes often become public-sector obligations.

The machinery of representative government works best when it is used to apportion a growing economic pie. For example, when the US economy was experiencing 4% trend growth, real GDP could be expected to double in 18 years, comforting parents about their children’s economic future. At the current trend of 1.5% growth, the period needed to double GDP stretches to 48 years, darkening the economic prospects of the grandchildren. In those circumstances, will elected officials make the hard decisions needed to get from economic stabilization to sustained recovery?

Carmen Reinhart is Professor of the International Financial System at Harvard University’s Kennedy School of Government. Vincent Reinhart is Chief Economist for Standish Mellon Asset Management.

By Carmen Reinhart and Vincent Reinhart

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