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The Current Economic Sweet Spot Is Not the “New Normal”

As the year 2018 begins, the world economy is gathering speed. The new World Economic Outlook Update revises our forecast for the world economy’s growth in both 2018 and 2019 to 3.9 percent. For both years, that is 0.2 percentage points higher than last October’s forecast, and 0.2 percentage points higher than our current estimate of last year’s global growth.

This is good news. But political leaders and policymakers must stay mindful that the present economic momentum reflects a confluence of factors that is unlikely to last for long. The global financial crisis may seem firmly behind us, but without prompt action to address structural growth impediments, enhance the inclusiveness of growth, and build policy buffers and resilience, the next downturn will come sooner and be harder to fight.

Every government should be asking itself three questions today. First, how can we raise economic efficiency and output levels over the longer term? Second, how can we support resilience and inclusiveness while reducing the likelihood that the current upswing ends in an abrupt slowdown or even a new crisis? Third, how can we be sure to have the policy tools we will need to counter the next downturn?

Near-term prospects

Looking first at where we are now, how do we see the world economy in the near term?

The primary sources of GDP acceleration so far have been in Europe and Asia, with improved performance also in the United States, Canada, and some large emerging markets, notably Brazil and Russia, both of which shrank in 2016, and Turkey. Much of this momentum will carry through into the near term. The recent U.S. tax legislation will contribute noticeably to U.S. growth over the next few years, largely because of the temporary exceptional investment incentives that it offers. This short-term growth boost will have positive, albeit short-lived, output spillovers for U.S. trade partners, but will also likely widen the U.S. current account deficit, strengthen the dollar, and affect international investment flows.

Trade is again growing faster than global income, driven in part by higher global investment, and commodity prices have moved up, benefiting those countries that depend on commodity exports.

Even as economies return to full employment, inflation pressures remain contained and nominal wage growth is subdued. Financial conditions are quite easy, with booming equity markets, low long-term government borrowing costs, compressed corporate spreads, and attractive borrowing terms for emerging market and developing economies.

Explaining the upturn

The current upturn did not arise by chance. It began to take hold in mid-2016 and owes much to accommodative macroeconomic policies, which supported market sentiment and hastened natural healing processes.

Monetary policy has long been and remains accommodative in the largest countries, underpinning the current easy global financial conditions. Even though the United States Federal Reserve continues to raise interest rates gradually, it has been cautious, having wisely responded to the turbulence of early 2016 by postponing previously expected rate increases. The European Central Bank has started to taper its large-scale asset purchases, which have played a critical role in reviving euro area growth, but has also signaled that interest-rate increases are a more distant prospect.

Moreover, fiscal policy in advanced economies has, on balance, shifted from contractionary to roughly neutral over the past few years, while China has provided considerable fiscal support since its growth slowed at mid-decade, with important positive spillovers to its trade partners. In the U.S., of course, fiscal policy is about to take a markedly expansionary turn, with complex effects on the world economy.

Not the “new normal”

Our view is that the current upturn, however welcome, is unlikely to become a “new normal” and faces medium-term downside hazards that likely will grow over time. We see several reasons—to some extent reflected in our medium-term growth projections—to doubt the durability of the current momentum:

Policymakers must face the challenges

Perhaps the over-arching risk is complacency. While the current conjuncture might appear to be a sweet spot for the global economy, prudent policymakers must look beyond the near term.

No matter how tempting it is to sit back and enjoy the sunshine, policy can and should move to strengthen the recovery. Now is the time to build policy buffers, reinforce defenses against financial instability, and invest in structural reforms, productive infrastructure, and people. The next recession may be closer than we think, and the ammunition with which to combat it is much more limited than a decade ago, notably because public debts are so much higher.

An upswing so broad also furnishes an ideal moment to act on a range of multilateral challenges. These include countering global financial stability threats, including cyber-threats; strengthening the multilateral trading system; cooperation on international tax policy, including the fight against money laundering; and promoting sustainable development in low-income countries. Of especially urgent importance is to fight irreversible environmental damage, notably from climate change.

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