Global economy remains fragile; high-income countries suffering from slow growth. 
Providing information, analysis, and advice on global trends in the world economy. 
Now free. Daily and monthly updates on global economic developments and relevant topical issues. 
Moody downgrades Spain's credit rating
September 2010
Euro area industrial orders slump....Euro government bonds rise
Important developments today:
1. European government bonds climb on speculation Fed may resume debt buyback
2. Euro area industrial orders slump in July
European government bonds climb on speculation Fed may resume debt buyback. European government debts rallied on Wednesday, driving the yield on German 30-year bond to lower than 3% for the first time in a week, amid speculation the Federal Reserve may resume another wave of asset purchases (or so-called quantitative easing) to provide more cash into the economy. The benchmark German 10-year bund yield slid the most in a month to 2.34%, with the yield on the equivalent French bond dropping 10 basis points (bps) to 2.7%. The U.K. 10-year gilt fell 15 bps to 2.97% on speculation the Bank of England would also ease monetary policy, while the yield on 10-year U.S. Treasury slid 4 basis points to 2.54% after falling 14 bps yesterday. Notably, the yield on Portuguese bond fell in line with other European securities, after the country sold €750 million ($ billion) of government debt maturing in 2014 and 2010.
Euro area industrial orders slump in July. New industrial orders across the euro area dropped sharply in July (-2.4%), the largest monthly drop in 19 months. The momentum growth picked up since the beginning of this year now appears to be trending down. Capital good orders, which had helped power the growth in industrial orders, slumped to a fall of 5.1% in July in contrast with the 3.8% rise in June.
These figures lend support to the expected slow down in euro area growth in H2 2010. As the global economy slows down, export orders which had contributed to the rapid recovery in industrial orders among euro area countries, including Germany [see Chart at http://gem or http://www.worldbank.org/gem] is also slowing down. Other euro area specific concerns contributing to this slowdown include lingering concerns on sovereign debts in the euro area, planned cuts in fiscal deficits and high unemployment levels which is holding back purchases of consumer durables. Indeed, orders of durable consumer goods which fell by 3.2% (m/m) is the only order category to have dropped on an annual basis in July, highlighting the difficult spending environment for consumers.
Source: World Bank DEC Prospects Group and Thomson Reuters.
Among emerging markets:
In Central and Eastern Europe and the CIS, Hungary’s retail sales climbed 1.7% y/y in July compared to June’s decline of 4.6% y/y, in a release by the Statistics Office. This is the first time in 41 months that retail sales rose.
In Middle East and North Africa, Kuwait’s Central Bank indicated that the country’s M1 money supply growth reached 12.1% y/y in August from July’s 17.9% y/y whilst M2 money supply growth was 2.3% y/y and 1.2% y/y for the same periods.
In Sub-Saharan Africa, South Africa’s current account deficit decreased from 4.6% of GDP in Q1 to 2.5% in Q2, led by a recovery in the exports of commodities, automobiles and tourism receipts as stated in the Reserve Bank’s Quarterly bulletin. During the 2010 World Cup, retails sales increased 7.9% in July and consumer spending reached an annualized 4.8% growth in Q2.
U.S. housing starts jump in August
Important developments today:
1. Two year U.S treasury notes reach record lows
2. U.S. housing starts jump in August
Two year U.S treasury notes reach record lows. In early trading today, U.S. treasury prices rose on speculation that the Federal Open Market Committee (FOMC), which meets later today, will increase purchases of U.S. debt if economic growth slows. The yield on the two-year note fell by 1 basis point to 0.46% after touching an all-time low of 0.4479%. The ten-year note has dropped for three consecutive days and is trading at 2.67%.
The ten-year notes have been rising since August 10 when the FOMC announced at its meeting that it would keep its bond holdings level by using proceeds of principal repayments to purchase U.S. debt to support the recovery. The Fed has bought $28.1bn of treasuries since August 17 using these principal repayments, hence keeping holdings in its System Open Market account at about $2 trillion.
U.S. housing starts jump in August. U.S Housing starts rose by 10.5% (m/m) to an annualized rate of 598,000 in August. Housing starts had risen to 679,000 in April, its highest level since the beginning of the crisis [see Chart at http://gem or http://www.worldbank.org/gem]. However after the expiration of the government tax breaks for new and existing home buyers in April, housing starts tumbled to a low of 539,000 in June and barely increasing in July. The August increase is welcome news to the housing market and may well suggest that the bottom might have been reached in this post-government tax incentive phase. This is also consistent with figures released yesterday showing that the U.S housing market index, a measure of builder confidence, has stabilized at 13 after tumbling from its peak of 22 in May 2010. However, with a sluggish jobs market, tight consumer credit conditions and mounting foreclosures that swell the supply of houses, recovery in housing starts will continue to remain a challenge.
Source: World Bank DEC Prospects Group and Thomson Reuters.
Among emerging markets:
In Latin America and Caribbean, Brazil, Latin America’s largest economy, current account deficit widened from 2.24% of GDP in the year through July to 2.32% in the year through August. The widening of the deficit is occurring at a time where the real is appreciating strongly on account of strong inflows of foreign investment. In August, Brazil attracted $2.328 billion worth of foreign direct investment.
Elsewhere in Latin America and the Carribean… Retail sales in Mexico fell slightly in July by 0.01%. The Mexican economy, which is tied to that of the U.S via strong trade and financial links, is recovering from one of the deepest contractions experienced. The moderation of growth in the U.S. as well as in Europe in H2 2010 will remain a check on Mexican economy’s recovery prospects.
In Sub-Saharan Africa, Nigeria, the second biggest economy in sub-Saharan Africa, the central bank raised the bench mark interest rate to 6.25% from 6%. Inflation increased to 13.7% in August (y/y) from 13% the previous month. The central bank projects the Nigerian economy to expand by 7.78% in 2010.
Builder confidence in U.S. housing market low
Important developments today:
1. Russian banks continue to tap the international bond markets
2. Builder confidence in U.S. housing market still very low
Russian banks continue to tap the international bond markets. Russian banks have been issuing foreign bonds at a record pace thus far this year as they have taken advantage of low borrowing costs. Offerings by OAS Sberbank and Alfa Bank last week brought total international bond sales by Russian financial firms in 2010 to $12.1 billion (78% of total overseas issues by Russian companies). This is the highest level of bond sales by banks since the government defaulted in 1998.
In the after math of the financial crisis in 2008, Russian banks were initially cut off from international debt market. However with 5% growth in the economy in 2009, Russian banks have recently returned, with some success. Russian state lender Sberbank returned to the Eurobond market last Friday with a $1 billion seven-year offering. Russia’s largest lender had already come to the market in June, raising $1.5 billion from 5-year bonds. Alfa Bank was also in the market on Friday with $1 billion, seven-year offering with a yield of 7.875%. The new bond is the largest foreign bond offering from a private Russian bank.
Builder confidence in U.S. housing market still very low. The U.S. Housing Market Index, a measure of confidence among U.S. home builders, remained unchanged at 13, the lowest level recorded since March 2009 [see Daily Chart ]. On account of the government tax credit, which has now expired, the index reached its 2010 peak of 22 in May, but has since been declining and now appears to have stabilized at a new level- reflecting no government tax credits. As long as U.S unemployment levels remain high (9.6%) and continued competition from foreclosed and distressed properties that are below the cost of construction persist, home builders will continue to operate in a challenging environment.
Source: World Bank DEC Prospects Group and Thomson Reuters.
Among emerging markets:
In East Asia and the Pacific, Thailand’s exports rose for a 10th consecutive month in August, this inspite of a 8.4% appreciation in the baht in 2010. In Q2 surging exports helped the Thai economy expand by 9.1%. With a deceleration in the global economy, the exports surge in Thailand is likely to moderate.
In Middle East and North Africa, Jordan’s trade deficit widened to 9% (y/y) for the first seven months of 2010. The main drivers of the increased deficit are crude oil imports, and vehicles and motorcycles, which increased by 33.6% and 21.3% respectively.
Europe and the United States object to yen intervention
Important developments today:
1. Japanese intervention to weaken yen draws criticism
2. U.S. CPI moves up 0.3% in August (m/m) on higher food and fuel prices
Japanese intervention to weaken yen draws criticism. Reactions from abroad to the September 15th intervention by the Japanese Ministry of Finance (MOF) to weaken the yen (reported by local press as sales of some $20 billion in yen securities on an “unsterilized basis) were largely critical, asking the Japanese authorities to refrain from such operations in future.
The MOF operations served to weaken the yen-dollar cross rate by more than 3% since September 15, trading at ¥85.72 per dollar today in Tokyo, up from intra-day levels as low as ¥82.50 earlier. The Chairman of the EU Council of Finance Minister, Jean-Claude Juncker, said in an interview that the ministers were “insisting that Japanese authorities step back from unilateral interventions.” Moreover, U.S. Senate Ways and Means Committee Chairman Carl Levin called the action “deeply disturbing”. The reply from Japanese financial officials was prompt, with Finance Minister Yoshihiko Noda defending the first intervention on behalf of the yen since 2004 as a move to thwart deflationary pressures tied to a rapidly appreciating currency: “...with deflation, it is undesirable that the strong yen be prolonged.”
U.S. CPI moves up 0.3% in August (m/m) on higher food and fuel prices. For a second month in succession the “headline” version of the consumer price index added 0.3%, as food prices (up 0.2%) are being affected by developments in global wheat, other grains, and fats & oils markets; and as the cost of various refined fuel products moved 2.3% higher in the month. On a year-over-year basis, headline CPI is running at a still moderate 1.2% pace, contrasted with advances of more-than 2% at the start of the year. Price changes for other goods and services were mute in August, and the “core” measure of CPI (excluding food and fuels) remained unchanged, up a modest 1% from August 2009 levels [see chart].
.gif)
Source: World Bank DEC Prospects Group and Thomson Reuters.
BNB consumer confidence holds at 30-month high in September. The Belgian National Bank’s bellwether readings of consumer sentiment (examined closely as representative of broader trends in the Euro Area), remained unchanged in September, but was holding at a 30-month high. Better news on GDP for Belgium (up 2.8% during the second quarter, saar), was a factor upholding confidence, and the Bank also reports that deep concerns among survey respondents on labor market conditions eased with this news. The survey shows a 4-month uptrend in improved optimism on the job front.
Among emerging markets:
In East Asia and the Pacific, China’s Central Bank released its Financial Stability Report today, mainly supporting a stance on currency stability: “large fluctuations in the dollar’s exchange rate may impede the global economic recovery” stated the report. The report also mentions that a rapid depreciation of the dollar could lead to an increase in commodity prices thereby causing asset bubbles. China’s monetary policy kept a dollar-pegged exchange rate until June 2010 in response to the financial crisis. The Central Bank’s report expects China to continue growing in a “steady and relatively fast” manner in 2010.
In Latin America and the Caribbean, Brazil’s Ministry of Labor reported 300,000 new jobs in August, an increase of 23.7% over the same period in 2009 reaching 1.95 million new jobs for the 2010 to date.
In Central and Eastern Europe, Eastern Europe’s outlook for growth remains unchanged from previous expectations, according to the European Bank for Reconstruction and Development, which places regional growth at 3.5% in 2010 and 3.9% for 2011, as released by the London multilateral today. Poland’s industrial production advanced 13.5% y/y in August, and in seasonally adjusted terms, 12.7% y/y and 1.5% m/m as released by the Central Statistical Office. Also in August, Poland’s producer prices increased 4.1% y/y and declined 0.2% on a monthly basis.
U.S. Industrial Production still on the rise
Important developments today:
1. EU unveils new rules for financial markets
2. U.S. Industrial Production up in August
EU unveils new rules for financial markets. The European Union proposed on Wednesday tougher new rules to curb derivative trading and short-selling, two loosely regulated forms of speculative trading activities that have been blamed by some for contributing to the global financial crisis. The new rules would require over-the-counter (OTC) contracts to be cleared centrally and be reported to “trade repositories” in order to allow regulators to have a better grip on the market activity. The proposed rules would also give national regulators in Europe the power to temporarily restrict or ban short-selling in case of serious financial instability. Short-selling—selling a borrowed security with the intention of repurchasing it later at a lower price—has been blamed for exacerbating some of the sharp downswing in share prices during the financial crisis. In particular, the controversial practice of naked short-selling, which sell shares without having made any arrangements to secure them, has been heavily criticized. The proposals still need to be approved by EU member states and parliament.
U.S. industrial production up in August. In signs of a continued recovery, U.S factories, mines and utilities increased output in August, the 13th monthly increase since July 2009 [see chart]. In figures released by the Federal Reserve today, U.S. industrial production increased by 0.2%, a decline from the 0.6% recorded in July. Unlike the July production figures that were driven by an 8.3% rise in the production of motor vehicles and parts, in August motor vehicle production served as a drag, falling by 5.2%. On the brighter side, August figures show that the increase was driven by increases in the purchase of business equipment (0.7% m/m), thereby confirming that U.S companies continue to replace outdated equipment. With consumer demand still in the doldrums, business investment has been important to US growth. In Q2 2010, non-residential fixed investments, which includes industrial output, contributed 1.54% to U.S GDP growth of 1.6%. However, going forward, industrial production could be more constrained as global growth prospects moderate on the back of a waning inventory cycle and winding down of government stimulus programs.
Source: World Bank DEC Prospects Group and Thomson Reuters.
Among emerging markets:
In East Asia and the Pacific, China’s foreign direct investment (FDI) in August increased by 1.4% to $7.6 billion, in a release by the Ministry of Commerce.
In Central and Eastern Europe and the CIS, Russia’s industrial production increased 7% y/y in August, in a release by the Federal State Statistics Service.
In Sub-Saharan Africa, Ghana’s inflation reached 9.4% y/y in August compared to July 9.5%, stated the country’s Statistical Service. Inflation in Ghana has been decreasing since last year’s 20.7% in June.
U.S. retail sales back up, Brazil to sell $500 million international bonds
Important developments today:
1. Brazil to sell $500 million of international bonds
2. U.S. retail sales back on the rise
3. German investor confidence continues its decline
Brazil to sell $500 million of international bonds. Brazil’s government plans to raise about $500 million with the reopening of its global bonds that mature in 2041, according to a person close to the transaction. The last sovereign debt issue by Brazil was in July, when it raised $825 million with the reopening of its 2021 global bond. In a statement, Brazil’s Treasury said the country is retapping bonds without specifying the amount. The bonds will be offered to investors in North America and Europe on Tuesday, and some of securities will then be offered to Asian investors, according to the Treasury statement.
Recently, large Brazilian companies, including mining company Vale SA, the Brazilian Development Bank, and telecommunications company Telemar Norte Leste SA, have come to the international bond market. In the past week they raised a combined total of $6 billion. Brazilian corporates are taking advantage of near-record low borrowing costs amid growing investor appetite to secure long-term financing. More Brazilian companies are expected to tap the market soon.
U.S. retail sales back on the rise. For the second month running, U.S. consumers increased spending on groceries, clothing, sporting goods, health and personal care items, gasoline, and other general merchandise. Figures released today by the U.S. Department of Commerce show August retail sales jumped by 0.45% (m/m, saar), the highest increase in 5 months. Compared to a year ago the August figures were up 3.6% [see chart]. Against the backdrop of fall in retail sales in May and June, which raised concerns of the possibility of a double-dip among certain commentators, given the size of consumer spending in the U.S GDP (70%), the recent retail sales data bodes well for continued growth, even if at a more moderate level. Nonetheless, consumer spending will continue to be constrained by elevated levels of unemployment (9.6%) and the need to deleverage household indebtedness from their current high levels (household debt to income was 119% in Q1 2010).
Source: World Bank DEC Prospects Group and Thomson Reuters.
German investor confidence continues its decline, 5 months running. The ZEW index of investor expectations, which seeks to predict developments six months ahead, fell to a 5 month low of negative 4.3, according to a release today by the ZEW Center for European Economic Research in Germany. This fall should be seen against the backdrop of the very strong performance of the German economy in both Q1 and Q2 2010, on the back of the global rebound. Further, the slowdown in global growth and implementation of fiscal austerity in selected eurozone countries continues to weigh on investor sentiments going forward.
Among emerging markets:
In South Asia, India’s wholesale price index increased to 8.5% in August in y/y terms. In July the figure was 9.5%.
In Latin America and the Caribbean, Brazil retail sales increased 0.4% m/m and 10.9% y/y as released by the country’s national statistics office.
In Central Europe and the CIS, the Slovak Republic revised its forecast for the country’s GDP to 4% and 3.3% growth in 2010 and 2011 respectively, from a previous 3.2% and 3.8%, on account better expectations for the external environment.
Treasuries continue to tumble; US inventories rise by the highest in 2 years
Important developments today:
1. Treasuries continue to tumble following last week’s sell-off
2. U.S. inventories rise by the highest in two years
Treasuries continue to tumble following last week’s sell-off. U.S. Treasury prices fell for a fourth day on Monday, pushing 30-year bond yields to a one-month high. Higher-than-forecasted industrial production in China and a slower phase-in of bank capital requirements boosted investor sentiment for riskier assets, undermining demand for perceived safe-haven government debt. Treasury prices are likely to fall further in the days ahead as analysts speculate tomorrow’s report will show U.S. retail sales advanced for a second month, an indication of the economic recovery taking hold.
Yields on 30-year bonds climbed 3 basis points (bps) to as high as 3.93% this morning, the highest since August 13, while the 10-year note yield was little changed at 2.8%. Supply concerns have also fueled an increase in U.S. Treasury yields after last week’s $67 billion worth of government bond auctions as well as a strong corporate bond issuance.
U.S. inventories rise by the highest in two years. U.S. wholesale inventories increased by 1.3% in July, the highest since July 2008 [see chart]. The increase was broad-based (durable and non-durable goods), reflecting confidence by wholesalers in the economic recovery.
Wholesalers account for about 30% of all business inventories in the United States, with manufacturers and retailers making up the rest. In Q1 and Q2, the change in real private inventories added 0.63% and 2.64% to U.S. GDP growth. The continued rise in business inventories augurs well for growth in Q3. However, given the fast replenishments of stocks, the ability of inventories to contribute to growth will be limited. A pick-up in the labor market, which should boost consumer spending, will create a more sustainable growth path.
Source: World Bank DEC Prospects Group and Thomson Reuters.
Among emerging markets:
In East Asia and the Pacific, China’s industrial production growth increased by 13.9% y/y in August with a 0.5% increase m/m. Chinese retail sales also increased 18.4% y/y and 0.5% m/m, while the accumulated growth YTD compared to 2009 for the same period is 18.2% higher. The Consumer Price Index (CPI) grew 3.5% y/y and 0.2% m/m in August while Producer Prices for manufactured goods reached 4.3% y/y and 0.5% m/m.
In Latin America and the Caribbean, Peru’s central bank increased its reserve requirement for short-overseas loans to 75% of borrowings abroad from a previous 65%. This measure was put in place to limit credit growth from driving inflation.
In the Middle East and North Africa, Jordan’s inflation decreased to 3.2% from 4.8%, according to a release by the Jordan Department of Statistics.
In sub-Saharan Africa, South Africa’s consumer confidence index increased from 14 to 15, the highest level since 2007. This was released in a report by the First National Bank and the Bureau for Economic Research.
Japan's economy grows faster than previously estimated
Japan’s economy grows faster than previously estimated. Revised GDP data released by Japan’s Cabinet Office shows that GDP grew at an annualized rate of 1.5% in Q2 of 2010 [see chart]. This is higher than the initial estimate of 0.4% reported a month earlier. The main change accounting for the revision was the higher than previously estimated spending on capital goods by companies. Capital investment advanced 1.5% from Q1, higher than the 0.5% initially reported. Contributions from net exports remained unchanged at 0.3%. Similarly, the contribution from consumer spending, which accounts for some 60% of the economy, remained unchanged. However on account of the winding down of government stimulus measures, including programs aimed at boosting spending on cars and electronics, the contribution of government spending accounted for 0.1% of growth in Q2.
Besides the slowdown in economic activity in the economies of Japan’s major trading partners, the rise in the yen to a 15-year high continues to pose downside risks to growth in Q3 for Japan’s export-dependent economy. The rising yen could drive investments abroad as Japan’s multinational companies seek to protect profits. In response, Japan’s government has unveiled a 915 billion yen ($10.92 billion) stimulus package on Friday, seeking to prop up employment, consumer spending, and corporate investment in the domestic economy.
Source: World Bank DEC Prospects Group and Thomson Reuters.
In Canada jobs rose by 38,500 in August, following a drop of 9,300 in July. This is the seventh gain in jobs over the past 8 months. The unemployment rate rose to 8.1% from 8% on account of an extra 53,500 joining the labor market, in part a reflection of increased confidence by job seekers of their ability to find jobs. The strengthening labor market should help boost household spending in Canada.
Among emerging markets:
In South Asia, India’s industrial production in July jumped to 13.8% y/y compared to a 5.8% y/y in June, as reported by the Indian Ministry of Statistics in New Delhi.
In Central and Eastern Europe and the CIS, Romania’s consumer price index increased to 7.5% in August compared to July’s 7.1%, as released by Romania’s Statistics Institute. The government’s outlook for the year’s end rate is 7.8%. Hungary’s consumer price index slowed 0.6% in August relative to July, but increased 3.7% y/y, stated the Hungarian Statistics Office. Both changes were largely driven by fluctuations in prices of seasonal food items. Hungary’s central bank targets a 3% inflation rate at the end of the year.
In the Middle East and North Africa, Dubai’s state-owned company, Dubai World, has received clearance from creditors to change the terms of its $25 billion debt, thereby allowing the restructuring of $14.4 billion in bank loans and $8.9 billion of government liabilities.
Prospects Daily: US initial claims decline, trade deficit narrows sharply in July
Important developments today:
1. Emerging market equities rebound as European debt concern ease
2. U.S. initial claims decline
Emerging market equities rebound as European debt concern ease. Developing-country shares rose for the first time in three days as the latest bout of worries over Europe’s debt woe eased, though the overall sentiment across stock markets remains cautious. Renewed concerns about the European banking sector and the potential impact on government debt levels have dented demand for risky assets this week. The MSCI Emerging Market Index advanced 0.3% today, but the gauge is still down 3.8% from this year’s high on April 15. Notably, the Philippine benchmark climbed for an eight day and closed at a record high and Russia’s Micex Index gained 0.9% on robust economic growth and rising oil prices. In contrast, China’s Shanghai Composite Index declined 1.4%, the most in two weeks, amid speculation that the government will step up measures to cool the property sector. Meanwhile, emerging-market bond spreads over comparable U.S. Treasuries tightened 6 basis points (bps) to 285bps today, according to JPMorgan’s EMBI+ Index. Stable spreads are prompting emerging market issuers to come to the market. Indeed, Russia’s state bank Sberbank and the Philippine government are expected to issue global bonds next week.
U.S. initial claims decline. The Labor Department reported today that the number of U.S. workers filing new claims for unemployment insurance fell by 27,000 to a total 451,000 for the week ending September 4th.The four-week moving average- which gives a better idea of trends by smoothing out short-term volatility- decreased by 9,250 to 477,750, the lowest level since July, but still some 10,000 higher than existed at the beginning of 2010 [see chart]. Some 4.48 million people were receiving state unemployment checks in the week ending August 28th. This figure does not include Americans receiving extended benefits under federal programs.
Having dropped sharply from the peak levels of 650,000 per week in April 2009, the pace of slowdown in initial unemployment claims has reduced significantly since the beginning of 2010, pointing to persisting weaknesses in the U.S jobs market. Last week the Labor Department reported that 67,000 workers were added to companies payroll. The manufacturing sector has been the engine for job creation from the private sector. However, overall businesses continue to be hesitant in hiring new workers in an environment of subdued sales and uncertainty about the growth prospects for the second half of the year. The continued lack of jobs growth is restraining consumer spending, which accounts for some 70% of the US economy, and serving as a drag on economic activity including recovery in the housing market.
.gif)
In other U.S. economic news, the U.S. trade deficit contracted sharply in July, posting its biggest drop in 17 months, as exports of airplanes surged and imports fell across the board. The U.S. deficit in international trade of goods and services narrowed by 14% to $42.78 billion from a revised $49.76 billion the month before, the Commerce Department said. In Q2 net exports served as a significant drag to US economic growth, subtracting 3.2% from growth, when GDP expanded by 1.6%. The narrowing of the trade deficit should provide support to GDP growth in Q3.
In Germany, final August consumer price data from the Federal Statistical Office show readings of 0.0% (m/m) and 1.0% (y/y). The annual rate of inflation has thus retreated from 1.2% (y/y) in July. With a robust recovery underway and low downside risks to inflationary pressures, the low inflation levels should provide support to German private consumption.
In related news, Eurostat’s flash inflation estimate rose by 1.7% in July (y/y), up from the 1.4% gain in June. No
breakdown for core inflation was provided, however it has remained flat over the past few months, implying that most of the gains were due to the volatile elements of food and energy prices. With wage growth limited by high unemployment levels, labor market developments will put downward pressure on underlying core inflation levels in the near term.
Among emerging markets:
In East Asia and the Pacific, South Korea’s benchmark interest rate remains constant at 2.25% as stated by South Korea’s Central Bank.
In Latin America and Caribbean, Brazil’s CPI reached 0.04% in August (m/m) with annual inflation through August slowing down to 4.49% for the year. Brazil’s Central Bank targets a 4.5% for the year.
In Central and Eastern Europe and the CIS, Hungary has abandoned its plan for increasing its government budget, accommodating demands from IMF and EU officials to keep it under 3% of GDP in 2011. Latvia benchmark interest rate is kept at 3%, stated the Central Bank today, as the country continues to recover from its recession.
In Sub-Saharan Africa, South Africa’s drops its benchmark rate by 50 bps, as announced by the South Africa Central Bank today in a move to move to attain its inflation target. The new repurchase rate is now 6% per annum, a decision bolstered by lower-than-expected inflation and a continuing negative output gap in Q2 with an outlook for slow growth.
To (Fiscally) Stimulate or Not to Stimulate, That is the Question....
As the U.S. economy increasingly sends mixed signals about the strength of its recovery, the significant sparring over the efficacy of the stimulus has regained an urgent relevance (papers, in PDF, available respectively here and here; the FT summarizes a wide range of opinions here). The latest salvo in the stimulus wars has been the battle between the so-called strucs versus cycs, with the former claiming that worker mismatches are the central problem in the current anemic labor market, while the latter dispute that cyclical factors are more to blame.[*] Of course, such theoretical stances are not only academic, since they inform and implicitly shape one's preferred policy response.
Rather than wade into the morass of the U.S. case, it is perhaps helpful to consider the bigger global context. After all, the financial crisis and subsequent slowdown instigated many governments around to the world to implement fiscal stimuli, of which America's and China's were merely the most prominent. It is perhaps useful to examine the association between the size of the stimuli---as measured by the size of the stimulus packages that governments implemented---and subsequent growth, to tease out whether there are any systematic patterns in the relationship.
At first glance, the relationship appears to be positive (see figure, top): this seems to vindicate the pro-stimulus camp, at least at the international level. This first impression, however, is deceiving. The positive slope is almost entirely due to the presence one outlier: and you guessed it---China. The size of China's stimulus, of course, has been the subject of much debate, with many observers claiming that the large stimulus had mainly been a reclassification of planned expenditures as stimulus. Repeating the exercise without the two big outliers, China and Saudi Arabia (which had pitifully little growth-bang for the buck in their $400 billion stimulus), and the positive relationship basically disappears (see figure, bottom). The bottom line is not so much that a large fiscal stimulus has either a positive or a negative effect on subsequent growth, but rather that---at the crude cross-country level---it is difficult to tease out any significant effect altogether.[†]
Source: Grail Research (stimulus data) and IMF IFS (growth data).
Notes: Stimulus data are for late 2008 to early 2009, while growth data are for 2009 (with the exception of Kenya, Kuwait, Mongolia, Nigeria, Serbia, where data are only available for 2008). Excluded outliers are China and Saudi Arabia, but the bottom figure is essentially the same by excluding only China.
Of course, this picture is somewhat incomplete. After all, much consternation has been made about the tradeoff between debt and deficits vis-a-vis the efficacy of a stimulus; in particular, Carmen Reinhart, among others, has repeatedly warned of the complicating effects posed by high debt burdens on stimulus and growth. The IMF has also recently noted the more general point that the post-crisis response to countercyclical macroeconomic policies are conditioned by pre-crisis vulnerabilities.[‡]
So let's try to provide a slightly more nuanced picture of the impact of fiscal stimulus, based on countries' external debt/GDP exposure. Slicing the data into countries with little external debt (< 10% GDP), moderate external debt (10-30% GDP), and high external debt (>30% GDP), we see that the growth impact of a stimulus is either negligible or slightly positive when countries have lower debt levels, but this turns negative when debt levels exceed a certain threshold (see figures). Similar pictures accrue when we use domestic debt (from BIS SecStats) instead of external debt, and when we combine the two measures into total public debt; with the difference being in the specific thresholds where the impact seems to shift from positive to negative. Interestingly, for total public debt, the contingent effect of a stimulus seems to comport with Reinhart and Rogoff's debt thresholds: there is a positive effect of a stimulus in countries with debt/GDP ratios of below 60%, little effect for countries up to 90%, and a negative effect in countries above 90%.[§]
Source: Grail Research (stimulus data), IMF IFS (growth data), and JEDH (external debt data).
Stimulus data are for late 2008 to early 2009, while growth data are for 2009 (with the exception of Kenya, Kuwait, Mongolia, Nigeria, Serbia, where data are only available for 2008). Debt data are gross external general government debt, for the 2008H1.
Now, it is important to be modest about how much we can draw from the above analysis. After all, the crude methodology above does not account for endogeneity and simultaneity concerns, the causal mechanisms have not been laid out, and the data do not account for the phasing in of stimulus packages. Moreover, we lack a counterfactual of how events would have played out in each country, had the stimulus package been absent, along with whether monetary policies may have played a complementary role. That said, it is useful to draw some tentative conclusions from the exercise.
Perhaps the best way to interpret the findings is that the size of fiscal stimulus, by our chosen measure, has a fairly limited impact on contemporaneous output growth. Moreover, to the extent that the fiscal package is actually accompanied by a nontrivial share of actual spending, the early effects of the stimulus have a fairly minimal impact on growth. This second conclusion should be qualified: since the early stages of a stimulus phase-in typically occurs in the deepest depths of a recession, it could well be that growth simply would have been worse. Finally, debt thresholds seem to matter for evaluating whether a stimulus is likely to have a growth impact or not. Generally speaking, when the debt burden gets too large, any positive growth effect of a stimulus appears to be washed away by the concerns that the country really shouldn't be taking on more debt.
In sum, fiscal stimulus does not appear to be the silver bullet that many of its most vociferous proponents would hope for it to be. That said, it would be both premature and irresponsible to declare that fiscal stimuli around the world are misguided. Rather, the wisdom of pursuing a stimulus is dependent on a whole range of factors, not least the extent to which a country already has fiscal space to enact such stimuli.
Postscript: Elsewhere at the Bank, Raj Nallari has also pointed out how the international jobs picture has not responded to fiscal stimuli as much as desired. Fritzi Koehler-Geib and her coauthors also make the point that there are tipping points after which debt can affect growth.
*. Amidst the sturm und drang, what Krugman and DeLong both miss, in my view, is the that mismatches in just two segments of the labor market can in fact induce broader unemployment, when general equilibrium effects are taken into account. Thus, when the mass of unemployed workers in the construction sector find it difficult to be reabsorbed into, say, the booming healthcare sector, overall aggregate demand may nonetheless be depressed if spending increases in the booming sector is not matched by the decline in the contracting sector. This could happen if there are sticky wages or habit persistence, or even the simple fact that workers in the booming sector do not have the time to increase their spending (remember, they are expanding their working hours as a consequence of the unexpected boom in their sector). With the shrinkage in aggregate spending, there is an accompanying contraction in employment in other labor market sectors unrelated to the two sectors where misallocation occurred. While this does not necessarily rehabilitate Austrian business cycle theory in full, it does nonetheless allow for the mismatch element that the two professors are so quick to denigrate.
†. This point can be made very slightly more formally. While the bivariate regression on the full sample has a statistically significant (at the 5 percent level) coefficient on the stimulus variable, the coefficients on the restricted sample (excluding outliers) is insignificant. The coefficient (standard error) in the full sample is 0.062 (0.03), for N = 66. The coefficients (standard errors) in the restricted sample without China only and without both China and Saudi Arabia are 0.028 (0.03) and 0.043 (0.05), N = 65 and N = 64, respectively.
‡. The IMF paper, however, concentrates on the size of reserve holdings as their central measure of vulnerability. Since reserve size has not featured in much of the contemporary debate on fiscal policy, we defer to their findings in that regard, and concentrate instead on the impact of debt instead.
§. The formal results in this case are somewhat more disappointing, however, with small sample sizes typically rendering the coefficients insignificant in most specifications. However, the signs of the coefficients are stable: the coefficients on the stimulus variable is positive, while that on debt is negative. When interacted, the coefficient on debt usually turns small and positive, but is dominated by the coefficient on the interaction term.