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World economy: 13 for 2013

World economy: 13 for 2013
Published 17 Jan 2013 

It feels like a long time since we had a boring year in the world economy. Financial crises, debt crises, food crises, natural disasters, geo-economic power shifts, social upheaval and revolution have all shaped and reshaped the economic environment in recent years. 

So will 2013 change the trend and give us a restful year? Or even just one where the downside risks are matched by some nice upside ones? Since Steve Grenville has recently reminded us of economists' failure to forecast, I'm going to do the cowardly but sensible thing and avoid making any predictions. Instead, I've put together thirteen suggestions (in no particular order) of things to look out for in the global economy this year. Here are the first four:

1. Fiscal follies in the US

We sorta, kinda avoided the fiscal cliff, but did so in part by creating a series of other tripwires for the dysfunctional US political process. Prominent among these is a pressing need to raise the debt ceiling, which potentially poses a worse problem than the so-called cliff did. For a while, it seemed like the sheer absurdity of the current US debate was going to get the recognition it deserved in the form of its very own trillion dollar commemorative coin. Sadly, that option has now been ruled out, but there's still scope for more fun and games before the (almost) inevitable compromise.

2. The longevity of eurozone optimism

After spending much of the past couple of years wondering whether the eurozone was doomed, financial markets have turned much more sanguine. Indeed, what was once thought to be a near-extinct species – euro bulls – are now again being found in the wild. [fold]

Much of the credit for this turnaround goes to Mario Draghi, president of the ECB and the FT's 2012 Person of the Year. His July 2012 speech, in which he promised 'to do whatever it takes to preserve the euro', is increasingly seen as a turning point, with the subsequent August announcement of Outright Monetary Transactions (OMT) giving force to his pledge. 

By effectively announcing that the ECB was finally ready to take on the role of lender of last resort, the OMT was supposed to reduce the tail risk of a euro collapse. And despite the fact that the ECB has yet to buy its first bond under the program, markets seem convinced, as sovereign yields on eurozone periphery debt have fallen sharply. 

Still, while the ECB has bought the eurozone project some much needed time, the fact remains that the eurozone gamble on the sustainability of a monetary union in the absence of a fiscal and banking union is a failed bet. That means that those fiscal and banking institutions will still need to be delivered if the show is to stay on the road, and while there has been some modest progress, there is still an awful long way to go, not least given the lack of political appetite. On that note, elections in Italy and Germany will be worth watching.

3. From Grexit to Brexit? 

Meanwhile, that push for greater eurozone integration is raising awkward questions for the UK's relationship with the EU. Prime Minister Cameron's speech this Friday will highlight some of the tensions now in play.

4. Japan's latest policy experiment

What happens if you have a massive asset bubble that then bursts? What does a lost decade look like? What happens when policy rates get driven to the zero bound? Does a massive expansion in the monetary base have to lead to inflation? What are the consequences for growth of a rapidly ageing population? And just how big a public debt-to-GDP ratio can a developed country manage if it has its own monetary policy? 

If you wanted to get advance notice of some of the key challenges now facing the world's developed economies, turns out it would have paid to spend some time looking at Japan. Now Japan is experimenting with monetary policy and central bank independence as Prime Minster Shinzo Abe exerts pressure on the Bank of Japan to raise its inflation target in an attempt to jumpstart Japan's long-moribund economy. The break from orthodoxy has been widely noted, with some arguing that Japan may now be a leading indicator for the end of the era of central bank independence.

Photo by Flickr user lrargerich.



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