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Monday 21 Aug 2017 | 03:23 | SYDNEY
Monday 21 Aug 2017 | 03:23 | SYDNEY

World economy: Keep optimism cautious



27 February 2013 16:32

Earlier this month I noted that, after several years dominated by bad economic news, the start of the current year had brought hopes that we might finally see a degree of stability return to what has been a demonstrably unstable global economy. While some of this shift in sentiment could be put down to sheer 'risk fatigue', it also reflected a sense of bullets dodged and pitfalls avoided, as some of the most feared tail risks facing the world economy have (so far, at least) failed to materialise.

This view is broadly consistent with the latest IMF assessment of global economic prospects as presented to the recent meeting of G20 finance ministers and central bank governors in Moscow. In particular, while noting that 'important downside risks remain', the Fund judges that (p.6):

Risks have become more symmetric in the short term. The ECB’s OMT has lowered important tail risks relating to the viability of euro. The US fiscal cliff has largely been avoided, while latest developments suggest that the risk of a hard landing has receded in China. Accordingly, the improved financial conditions and confidence could trigger stronger-than-projected global investment and growth.

After a period of prolonged gloom, we have started to see the emergence of some cautious optimism about the world economy. Still, as I pointed out in that earlier piece, it's important not to underestimate the persistent nature of many of the risks still facing the global outlook.

For a couple of examples, it's worth returning to my list of things to look out for the in global economy in 2013. The first two items on that list were US fiscal follies (where I stressed that, although we'd 'sorta, kinda' avoided the fiscal cliff, there were plenty of other tripwires ahead) and the longevity of eurozone optimism (where I pointed to the importance for sentiment of upcoming elections in Italy and Germany). We've recently seen significant developments in both areas.

First, in the US, the seemingly endless political fight over budgetary policy has now moved on to the sequestration, which comprises some US$1.2 trillion of automatic spending cuts scheduled to take place over the next ten years. Absent a last minute agreement, the sequestration process will kick in this Friday. That would to add to the fiscal drag already acting on the US and global economies this year, and could shave perhaps an additional half percentage point from US GDP growth (assuming no future adjustments were forthcoming). On top of that, there's the corrosive effect a failure to reach compromise would have on markets' already fragile confidence in Washington's ability to conduct sensible fiscal policy. And then there's the looming 27 March deadline for a possible government shutdown to worry about.

Meanwhile, in the eurozone, Italy's election results earlier this week delivered a sharp warning to investors inclined to become complacent about developments in the European periphery in general and the willingness of European voters to live with sustained austerity in particular.

So, while its true that this year started off on a relatively positive note for the world economy, the message from recent developments is that those inclined to cautious optimism need to keep the emphasis on caution.

Photo by Flickr user Mark Sinderson.

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