The Course towards Economic Recovery
After the UK referendum that initiated the country’s exit from the European Union (Brexit) and the election of Donald Trump as the 45th President of the United States, the global economy faces significant challenges. Various stakeholders, including market players, are deeply worried about global economic prospects, which will surely affect national economic performance.
However, after the first quarter of 2017, the global economic cycle indicates a high degree of optimism about a global economic recovery, especially among public policy-makers.
Main indicators
Several main indicators support our optimism on global economic prospects. First is the recovery of the US’ economic performance. After the slow recovery following the 2008 recession, the US economy experienced a boom. The labor market is on the brink of full employment, inflation has risen and household optimism has improved.
The unemployment rate has reached its lowest point in history at 4.7 percent, and joblessness among university graduates stands at just 2.4 percent. Average hourly income for workers has risen by 2.8 percent over the past year. The strong labor market and wage increaseshave triggered unemployed people to seek new jobs and increasedthe labor force participation rate.
The real indication that the US economy is on the brink of full employment is the significant rise in inflation. Core inflation has reached 2.2 percent, substantially higher than the 1.8-percent average rate in the previous three years. In the last three months, annual core inflation increased to 2.8 percent, far beyond the Fed’s 2-percent target.
Household wealth also increased. The price of homes increased by 5 percent in the last 12 months. The stock market increase has contributed to the increase in wealth of US citizens and put it on a wider basis.
Surveys point to a high level of confidence among US consumers about the country’s economic conditions. The University of Michigan Consumer Sentiment Index recently reached its highest level in the past 17 years. In February this year, the Conference Board Consumer Confidence Index reached its highest point in 15 years.
The processing industry has increased its monthly production over the past six months. Housing construction raced with rising demand, as reflected in the 6-percent increase of construction of new family homes over the past 12 months.
All of this shows that the US’ gross domestic product (GDP) in 2017 will surely rise at a faster pace than in the last four years. As trade and inventory data continuously change and cannot be used as early indicators of GDP performance, the real final sales data of private entities increased by 2.5 percent per annum and may signify strong growth of the US economy. Therefore, it can be estimated that the US GDP will grow by around 2.5 percent in 2017.
The second indicator is China’s economic development, as reflected in the ratio of retail expenditure to industrial production in the country. That figure can be used to assess the business cycle and it indicatesthe changing structure of China’s economyfrom one that is export-oriented to one based on domestic consumption,or from outward-looking to inward-looking.
The factthat China’s economy is experiencing a dramatic structural transformation also reflects in the GDP share of the secondary sector (processing and construction), which has plummeted from 47 percent in 2007 to 40 percent in 2016, and the significant increase in the tertiary sector (services) from 43 percent to 52 percent. Such a massive structural shift is a sign of the seriousness of the Chinese government to reform its economy towards an adequate rebalancing process.
Apart from that, data from China’s National Bureau of Statistics for the first two months of 2017 show a convincing increase in retail sales, industrial output, electricity consumption, steel production, physical investment and service sector activity.
Meanwhile, China’s foreign exchange reserves rebounded for the first time in eight months in February 2017, which means the pressure of foreign capital outflow has subsided. At the same time the People’s Bank of China increased its benchmark interest rate by 10 basis points to minimize the impact of a rising US federal fund rate on foreign capital flows.
Apart from that, China’s economic resilience is reflected in its international trade data. In January and February 2017, exports grew by 4 percent year on year, bouncing back from a 5.2-percent contraction in the final quarter of 2016.
The third indicator are strong signs of economic recovery in the EU. Since summer 2016, a majority of EU members have enjoyed a convincing economic recovery amid fears of EU disintegration triggered by Brexit and Trump’s election. Both incidents have triggered fears that the EU’s disbandment was just a matter of timewith the expected victory of populist parties in elections in the Netherlands, France, Germany and Italy.
One of the strong signifiers of the EU’s economic recovery is the monthly Ifo Business Climate Index on the German economy. The data can be used to monitor Europe’s economic cycle as a whole, considering that Germany is the center of Europe’s economy. If the index increases, it can be surmised that Europe’s economy is recovering as a whole. The Ifo index has been increasing since the second semester of 2016. It reached its highest point since the 2008 crisis in February 2017.
The EU had experienced a prolonged and worrying economic recession after the 2008 global financial crisis, especially due to Germany’s objection to fiscal and monetary stimulus for the EU to help the US get out of its 2010 recession. Germany’s veto on expanding the EU’s monetary policy using instruments such as quantitative easing was among the major reasons the EU almost disbanded in 2012.
However, drastic changes in EU policy and economic conditions occurred in March 2015, when the European Central Bank (ECB) launched a bond-purchasing program on a much more massive scale than the one the US had implemented. Since then, the ECB has implemented a highly lax monetary policy by purchasing some 2.3 trillion euros-worth of bonds in European markets.
By purchasing almost three times the amount of bonds issued by the EU, the ECB has effectively broken the rules of the EU by providing funding to cover for member countries’ fiscal deficits. Therefore, a system was rebuilt that strengthens the economic recovery between strong countries like Germany and weak countries like Italy or Spain. The ECB’s move swiftly reversed the fragmentation in the European banking system and eliminated the possibility of the EU’s dissolution, resulting in a significant increase in the optimism and confidence of investors, business players and consumers in Europe.
Several risks
Based on these indicators, in general the global economy is in fact moving towards recovery even amid the growing shadow of political populism in Europe and the US. Based on experience, the three indicators are signs that the global economy will see a significant performance increase.
If the G-7 summit in Sicily, Italy, in May 2017 and the G-20 leadership meeting in Hamburg, Germany, in July 2017, succeed in formulating an agreement to speed up global economic growth to avoid stagnation, that would be another reason for optimism. Nevertheless, such optimism is still shadowed by several risks that could become stumbling blocks for global economic growth. These include weak European banking conditions, over-leveraging at local governments in China and complicated financial regulations in the US.
Apart from that, the presidential election in France on May 7, 2017, is also worrying. If Marine Le Pen wins, global economic recovery would face more hurdles. However, if Emmanuel Macron’s moderate faction wins the election, we can be sure that the global economy will move faster towards recovery.
Hopefully, the global economic recovery will become more certain, giving rise to optimism about creating a more prosperous world.
TRI WINARNO
Bank Indonesia senior researcher
