CRISIS FOCUS

Fundamentals, Confidence and Policy

Entering the third year of the most serious economic crisis since the Great Depression, the world economy is still bogged down on the muddy road to recovery. The latest edition of Standard Chartered Bank’s monthly report, Global Focus, published on February 2, offered some analysis on the outlook of the global economy this year. Edited excerpts follow:

How the world performs this year depends on the interaction among economic fundamentals, confdence and policy. The fundamentals point to a multi-speed, policy-led global recovery—multi-speed because emerging economies look to be in much better shape and are expected to lead the recovery. In contrast, it will be a long, hard slog in Japan and in most advanced economies. For them, the recovery will be weak.

Around the world, confdence is the hardest factor to predict. The likelihood is that it will mirror economic data, with rising confdence adding to the recovery in the East and subdued confdence prolonging the adjustment phase in the West.

All of this points to the importance of policy. Over the last year, policy played a dominant role in stabilizing the world economy and the fnancial system. In terms of global economic policy, a number of issues stand out this year.

First is the need to avoid regulatory overkill. Regulation to address fnancial sector problems could have a clear bearing on the global outlook. Fear has arisen about the unintended consequences of such regulation, including concerns that poorly implemented regulation could limit the ability of banks to lend during the recovery.

The need to avoid premature policy tightening also exists and is probably the most important issue. Governments wish adamantly to return their fnancial systems to normal. Likewise, central banks are looking forward to the day when they can return interest rates to normal. Yet it is vital they do not do this at the same time. Too much, too soon may backfre.

In the West, generally, there is the genuine risk that fiscal policy could be tightened prematurely in order to ease the fears of the fnancial markets. It was reiterated at Davos that there have been many examples where a fnancial crisis has been followed by a sovereign debt crisis. For some, such a debt crisis was the imminent risk. Recent problems in Dubai and Greece have added to such worries. Yet it is too easy to say that because this happened before, it may repeat itself again.

Previously, it was often emerging economies with limited policy tools and institutions that fell into the trap of a sovereign debt crisis. The United States and many others are not in this camp. Yes, there may be sovereign debt issues in certain countries, but such fears need to be kept in context and judged on a case-by-case basis. But clearly, policymakers will be keen to minimize any contagion risks from countries in trouble.

Finally, the need exists to ensure the success of the G20. The fear is that many countries will talk globally but act nationally. There is no doubt that countries need to have the ability to implement policies to suit their domestic needs, but this should be within the framework of ensuring that there is common ground with global responses. A fear expressed at Davos was that the Doha trade round and the Copenhagen climate meeting do not augur well for the success of global policy coordination.