Almost a decade after the start of the financial crisis, the global economy does not seem to have fully recovered its previous vigor: Global growth has averaged just 2.6 percent between 2011 and 2015, substantially below an average pace of 4.0 percent over 2003–07. The slow expansion has been accompanied by repeated downward revisions of growth forecasts, suggesting that the impact of the crisis was deeper than initially thought, and that, beyond cyclical influences, structural factors may have lowered potential growth.
On the one hand, the current global slowdown is driven by various short-term factors affecting the demand side of the economy. Recent expansions in advanced economies, supported by massive monetary stimulus, turned out to be relatively modest, as ultra-low interest rates and unconventional tools did not manage to fully revive private spending, which remains damped by heightened economic and political uncertainty, lack of confidence, and debt overhang.
Developing countries and emerging-market economies have, in turn, suffered from spillovers coming from advanced economies. They were also affected by the transition to a more service- and consumption-oriented growth model in China, which had the effect of lowering demand for raw materials and commodities. This rebalancing in what has been the world’s growth locomotive, coupled with lower growth in advanced economies, damps near-term economic prospects for the rest of the world by further depressing international trade and commodity prices and by increasing financial market volatility. These forces were amplified by the recent domestic political turmoil in Brazil, and by heightened geopolitical tensions that have contributed to the ongoing downturn in Russia. These two economies played an important role in dragging down global growth in 2015.
On the other hand, many economists believe that at least the United States is now operating close to its potential as shown by the Federal Reserve’s repeated declarations that it will be tightening its monetary policy with more interest rate hikes this year and next. That said, growth in the United States has been disappointing by historical standards, which likely reflects more fundamental developments such as decelerating productivity and labor force growth.
Productivity growth has been slowing down in most developed countries. The financial crisis might have had an impact on productivity, but the long observed trend suggests that other important factors have been at work. The future of productivity growth, which drives consumption and economic growth, remains highly uncertain and debated among economists. Are we doomed to slow productivity growth for the foreseeable future? We don't know. Optimistic observers would note that the technological frontier appears to be advancing rapidly in some sectors and that reduced rate of productivity growth may reflect measurement issues. Pessimistic observers would argue that "low hanging fruits" of information technology have been collected and that we may have come back to more normal times regarding technological progress.
Moreover, demographics started to have an adverse impact on potential growth in some parts of the world. The working age population has been stagnating or even decreasing in most advanced countries—Japan being particularly affected, while the working age population is still growing in the United States and is expected to follow a similar path in the coming years in some emerging markets such as China. Lengthening lifespans, lowered fertility rates, and the retirement of baby boomers in advanced economies are the main factors driving this long-term trend. The decrease in the share of working people in the population also has strong implications for retirement systems and future fiscal policy, which could further affect potential growth.
What can be done to counter those headwinds?
First, some countries should reconsider their policy mix in the short run. Much emphasis has been put on monetary policy, which is approaching its limits in advanced economies. Fiscal policy should be used when available in advanced as well as in emerging markets to stimulate public investment in infrastructure, health or education, and boost sluggish demand. The new fiscal package in Japan proposed by Prime Minister Shinzo Abe represents an encouraging example of this approach. The Juncker plan in Europe, although considered insufficient by many economists, constitutes a small step in this direction.
Second, issues such as declining productivity growth and working population are of long-term nature, and monetary policy alone cannot address them. While there is disagreement about what the most effective policies would be to lift the long-run potential of advanced and emerging economies, some combination of improved public infrastructure and "structural reforms" such as better education, more efficient immigration system, encouragement for private investment, and more effective regulation all likely have a role to play in promoting faster growth of productivity and living standards in the long run.
Finally, a rethinking of the macroeconomic policy toolkit is needed. Some suggestions have been made to make monetary and fiscal policies less constrained and able to better respond to future recessions. The non-exhaustive list includes a higher inflation target in order to reduce the probability that advanced economies and particularly their central banks will in the future have to contend more than is necessary with the zero lower bound; the introduction of some kind of capital controls to prevent emerging markets from adverse effects of monetary policy in advanced economies, or even the issuance of long-term GDP-linked bonds in order to reinforce debt sustainability. However, more commitment from global policymakers is necessary as further delays with concrete actions will make the task of escaping the current low-growth momentum even more challenging.