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U.S. Economy Makes The World Go Round Or Rot

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By J C Suresh | IDN-InDepth NewsAnalysis

TORONTO (IDN) - Though the world is increasingly intertwined, the U.S. plays a unique role in the global economy, accounting for 11 percent of global trade and 20 percent of global manufacturing. The country’s global financial ties also run deep. Foreign banks hold about $5.5 trillion of U.S. assets, and U.S. banks hold $3 trillion of foreign assets.

While these interconnections have great benefits for the United States, they are not without risks, IMF Managing Director Christine Lagarde has warned, referring to the collapse of Lehman Brothers five years ago that ushered in “a harsh new reality” across sectors, countries, and the world.

“What happens elsewhere in the world – be it the success of recovery in Europe or the continued smooth functioning of supply chains in Asia – matters increasingly for the United States,” Lagarde said in a speech to business leaders at the U.S. Chamber of Commerce in Washington, D.C. on September 19. “The converse is also true. What happens here matters increasingly for the global economy.”

Her remarks, which focused on the interplay between the global economy and the U.S. economy, also highlighted the need to find joint solutions to secure a lasting, balanced and widely shared global recovery.

The good news, according to a new analysis by the International Monetary Fund (IMF) is that five years after the global financial crisis, the tensions and risks embedded in the world's largest economies – China, the euro area, Japan, Britain and the United States – have diminished, though these economies are not contributing to global activity as much as they might.

But the IMF envisages that if the five succeed in making improvements in their policies in mutually reinforcing ways, they would lift global GDP over the longer run by as much as 3 percent.

In a report on the “spillover effects” of the five economies, labelled as the “Systemic 5”, the IMF focuses on the impact of their policies on one another and on the rest of the world because of the large volume of trade and financial linkages in today’s economy.

The challenge for these economies, says the 2013 Spillover Report, has been to evolve policies that will help them reach their potential output without complicating, through spillovers, economic management in other countries.

Global imbalances narrow

The IMF reports say that while global growth has continued to disappoint, much else has gone in the right direction. Global imbalances have continued to narrow – for structural reasons, not just cyclical; exchange rates have moved closer to where fundamentals suggest they should be; and policies of the Systemic 5 have enabled them to avert far worse outcomes.

Indeed, concerted policy actions to avert some of the most significant tail risks facing the global economy are estimated to have saved 2-5 percent of global output. Global imbalances – defined as the gap between actual current account balances and those estimated by staff to be consistent with fundamentals and desirable policies – contracted in 2012 to about 0.75 percent of global GDP.

“External sector developments have been shaped by two key interrelated issues – the implications of policy measures, particularly in the advanced economies, to support growth and shifting risk sentiment,” noted David Robinson, Deputy Director of the IMF’s African Department and one of the lead authors of the 2013 Pilot External Sector Report.

The report published on August 1, 2013 says: “Both emerging markets and safe haven economies, including a number of smaller advanced economies, have seen episodes of significant capital flows, triggering a variety of policy responses. Patterns of reserve accumulation have varied greatly in 2012 – most emerging markets saw little or no change in reserves, while some advanced economies saw large increases. In addition, some oil-exporting countries continued to accumulate reserves, though the pace of accumulation slowed in the second half of 2012 as oil prices eased and domestic fiscal spending rose.”

While easy monetary conditions in advanced economies appear to have played some role in exchange rate movements and capital flows, much of the capital flows seen over the last few years were driven by other factors – such as growth prospects, and global risk appetite – these factors will remain key in determining individual country outcomes, the IMF says.

Managing spillovers

A key issue the Spillover Report analyses is the impact of quantitative easing monetary policies deployed by central banks in some countries to revive growth. Here, the IMF finds clear evidence of positive growth spillovers from quantitative easing in the United States so far. In the case of the United Kingdom and Japan, however, the spillover effects to date are more ambiguous. And negative side effects of quantitative easing in any country may emerge over time, and need to be monitored carefully, the reports caution.

Looking ahead, the policy settings of the world’s largest economies pose risks of adverse spillovers in a number of areas, stresses the IMF.

The eventual exit from quantitative easing monetary policies of central banks in the United States, the United Kingdom, and Japan, it says, is one example. “The impact of exit from these policies will depend largely on its timing: too late would risk fueling asset bubbles and imbalances, while too soon would kill growth. However, even with good timing, market reaction to the policy change could be disorderly, as developments in late May and June attest.”

The Spillover Report notes that Europe and Japan are at risk of getting stuck in a slow growth trap, and that one of the downside risks for China is an abrupt slowdown in growth. In Europe, structural reforms and financial sector reform will be essential; in Japan, full implementation of the Three Arrows of Abenomics (that is, the economic policies advocated by Japanese Prime Minister Shinzō Abe); and in China, policies to rebalance the drivers of growth toward domestic consumption and liberalize the financial sector.

Spelling out the world economic situation and prospects as of mid-2013, the development policy and analysis division of the UN secretariat, predicted in August that global growth will remain subdued in 2013 despite improved financial conditions and reduced short-term risks.

Most regions are expected to see a moderate pick-up in 2014, but growth will continue to be below potential and employment gains will be weak, it said, adding that short-term risks stemming from the euro area crisis, fiscal adjustment in the United States and a further slowdown in large developing countries have diminished, but not disappeared.

Enhanced international policy coordination is needed to mitigate negative policy spillovers and foster robust and balanced growth, the UN report said. [IDN-InDepthNews – September 21, 2013]

Picture: IMF Managing Director Christine Lagarde | Wikimedia Commons

2013 IDN-InDepthNews | Analysis That Matters

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