On the surface, the recently released forecasts of the IMF, the European Commission and the OECD look satisfactory, without being great. Upon closer inspection, unease dominates for a number of reasons: developments in emerging markets, China’s slowdown, slowing world trade growth and, above all, risks and uncertainties (protectionism, Brexit). OECD simulations of the impact on growth show the importance of avoiding that these risks materialise.

William De Vijlder May 2019

TRANSCRIPT

Behind the numbers: unease

In the past one month and a half, the IMF, the European Commission and, earlier this week, the OECD, have released their detailed outlook. All in all, the numbers look OK. The US should slow but starting from a high level, so next year growth should still be above or slightly above potential.

Eurozone growth is expected to be a bit better next year, at about 1.5%. However, judging by the titles, cautiousness, not to say, unease dominates.

The IMF speaks about “global expansion loses steam”, about “Waning Cyclical Forces in Advanced Economies” and “A Precarious Recovery in Emerging Market and Developing Economies”.

In comparison, the European Commission’s spring forecast title looks more factual: “Growth continues at a more moderate pace”. The OECD’s Economic Outlook sounds most bearish and boils down to a call of action:” A fragile global economy needs urgent cooperative action”.

This is a striking observation considering that the OECD forecast for the US is about 50bp above the others (2.8% this year, 2.3% next) whereas for the eurozone it’s in line with the IMF and the Commission. The causes for this unease, and on which the organisations agree, are well known. To mention a few: the slowdown of the corporate investment cycle, of world trade, the Chinese rebalancing, tariff increases, etc.

Policy uncertainty

Obviously, policy uncertainty is also playing a role in explaining the slowdown since the start of last year and, even more, in understanding why the outlook has become tougher to assess.

Whether and when there will be Brexit and what the future relationship will be with EU27 has become less clear. The much hoped for agreement between the US and China on trade, did not happen, quite on the contrary. Concerning trade relations between the US and the EU, the only good news is that possible tariff increases by the US have been postponed.

Estimating shocks

The OECD Economic Outlook does an interesting job in simulating the effects of different shocks.

The tariffs imposed by the United States and China in 2018, which are incorporated in the projections, are expected, by 2021, to have a negative impact on output in these two countries of about 0.2-0.3%. The new measures announced this May, if maintained, are estimated to have an additional impact of -0.2-0.3% on US and Chinese GDP by 2021 and 2022.

Should the United States and China impose 25% tariffs on all remaining bilateral trade, output would decline, by around 0.6% relative to baseline in the United States and 0.8% in China. Further uncertainty about trade policies could cause a risk in risk premia. A rise of 50 basis points in investment risk premia in all countries for three years would lower the level of global GDP 0.7% below baseline by 2021

In case of a hard Brexit, the increase in tariffs from WTO rules coming into effect would further reduce GDP by around 2% (relative to baseline) in the United Kingdom in the next two years. An unanticipated decline of 2 percentage points in the growth rate of domestic demand in China for two years could lower global GDP growth by close to 0.4 percentage point per annum. Of course, these shocks don’t need to occur simultaneously, but it is important to keep two things in mind. One, when growth is slowing, coping with uncertainty is all the more difficult and the confidence in forecasts takes a hit. Two, it is better to avoid breaking something rather than count on the possibility to glue the pieces together once something is broken. It means time has come to sit around the table.