State of the World Economy

Warwick J. McKibbinDirector, ANU Research School of Economics

Presentation to AHIA, 10 November, 2011

Overview

• The last decade – global structural change combined with poor macroeconomic policy

• Looking Forward– Growth– The Euro– Fiscal Risks– Inflationary Risks– Commodity Prices

• Conclusion

The drivers

• The world will be dominated by long term trends from – The emergence of the BRICS into the global

economy– Large demographic changes– Productivity and technical innovation– Impact and response to environmental problems

The 2000’s

• Emergence of China and India has caused a large structural shock for western economies

• Countries have made the mistake of not allowing adjustment

• 2001 recession met with loose monetary policy which led to a misallocation of capital

• Crisis in 2008 met with demand management policy when the problem was structural change and capital misallocation

Growth

World GDP Growth

-1

0

1

2

3

4

5

6

1980 1984 1988 1992 1996 2000 2004 2008 2012 2016

% p

a

Source: IMF World Economic Outlook Sept 2011

Euro Area – Industrial Production2005 Average = 100

Source: Eurostat

Germany

France

Euro area

70

80

90

100

110

120

2005M01 2007M01 2009M01 2011M01

Index

Portugal

Greece

Italy

Spain

70

80

90

100

110

120

2005M01 2007M01 2009M01 2011M01

Index

Fiscal Risks

Government Debt to GDP

Source OECD Economic Outlook 88 Database (November 2010)

Required change in underlying primary balance to stabilise debt by 2025 in per cent of potential GDP

Source OECD Economic Outlook 88 Database (November 2010)

Two problems in Europe

• Exchange rate in southern Europe need to depreciate because of productivity differences

• Fiscal positions unsustainble

The Euro

0

40

80

120

0

40

80

120

ECB Lending to Banks*

* Lending provided through monetary policy operations onlySource: central banks

Greece

Fixed-rate tenders fromOctober 2008 onwards

€b €b

Ireland

Portugal

Spain

Italy

2010200920082007 2011

By national central bank

Inflation Risks

l l l l l l l l l l l l0

500

0

500

Fed Holdings of SecuritiesWeekly

Agency MBS Agency debt US Treasuries

US$b US$b

2 0002 000

1 5001 500

1 0001 000

J2008

S D M J S D M J S2009 2010

D M2011

IMF Food Price IndexSDR, 1995 = 100

Sources: IMF; RBA

Index

Year-ended change

100

130

160

100

130

160

-30

0

30

-30

0

30

LevelIndex

%%

2005 201020001995199019851980

Consumer Price InflationYear-ended

-4

-2

0

2

4

6

-4

-2

0

2

4

6

Source: Thomson Reuters

2011

Headline

%US

Core

Euro area

200920072011200920072005

%

Asia – Policy Interest Rates

2011

India

%

l l l l l l l0

3

6

9

12

l l l l l l l 0

3

6

9

12

%

2008201120082005

China

TaiwanThailand

Malaysia

Philippines

Indonesia

South Korea

2005

Commodity Prices

Commodity prices

• Rising because of– Real growth in emerging economies (Chindia)– Loose monetary policies raising nominal demand

• The relative price of commodities likely to fall if – global supply responds– Growth in China falls– Non-commodity prices rise due to inflation

Conclusion

• The Emergence of China and India into the global economy is a major structural transformation

• US and Europe have not adjusted well but have tried to use demand policy to handle the shock

Conclusion

• Difficult but important to distinguish between relative price changes and overall inflation – the 1970s is an important lesson

• For commodity exporters the terms of trade increase is likely to reverse but the overall income gains will be positive as China becomes wealthier

Final thought

• Probability of a Euro crash is very very high