Martin Wolf on the perilous road to economic recovery

At the conclusion of the World Economic Forum last week, Christine Lagarde, MD of the International Monetary Fund (IMF),  stated “we have avoided collapse, but we need to guard against any relapse. 2013 will be a make-or-break year.” Her words reflected the renewed optimism of this year’s event – the first Davos meeting since 2007 where discussions centred on hope, prosperity and economic recovery, not fiscal tumult and economic calamity.

This optimism is shared by Martin Wolf, Financial Times columnist and one of the world’s most influential economic commentators, but his buoyancy is not without caveats; “the fact that the economies of the high-income countries have not fallen off their rickety bridge does not guarantee a swift return to growth. That may well come. But it is not yet ensured.”

What explains the rising beatitude? “One reason is that feared disasters – a break-up of the eurozone or a fall over the US fiscal cliff – have been avoided,” Martin writes. “Another is that substantial post-crisis adjustment has occurred, above all in the US, where private leverage and house prices have gone through a significant rebalancing: US private debt is back to 2003 levels relative to gross domestic product, for example. Yet another explanation is rising trust in the competence of policy makers. Above all, central bankers have used ultra-expansionary monetary policies to pull the economies for which they are responsible for a long time. The US Federal Reserve’s federal funds rate has been 0.25 per cent for more than four years, with more to come. Even the European Central Bank, the most cautious of the big central banks, has adopted what would have seemed an irresponsibly easy policy in any previous era, with interest rates at 0.75 per cent since last July.”

However, the future seems far from golden. In an update of its forecasts for the World Economic Outlook, the IMF has painted a far from rosy picture , of “2 per cent growth in the US, 1.2 per cent in Japan, 1.0 per cent in UK and -0.2 per cent in the Eurozone this year. It is also possible to envisage big problems arising from managing fiscal and monetary policy. The dangers are of tightening too soon or of tightening too late: too soon and the recovery may be aborted; too late and inflationary expectations may become embedded, once again”.

Martin concludes, “policy makers have, so far, responded successfully to the challenges the current crisis poses – however, in the case of the Eurozone, they were almost too late. A chance of a return to sustained growth is now emerging, though least of all in Europe. Substantial fiscal and monetary support is still essential. If policy makers sustain the effort, the world could be far closer to full recovery a year hence.”

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