The IMF released a study yesterday that urges advanced and emerging economies to make increasing potential output a policy priority. The study also seems to support the idea that the global economy is in a period of “secular stagnation”—a period of chronic low growth, low interest rates and low inflation—a theory that has been debated by several economists since the aftermath of the financial crisis of 2008.
The study, “Lower Potential Growth: A New Reality,” one of the analytical chapters of the IMF’s April 2015 publication of the World Economic Outlook, states that global potential output growth fell sharply since the onset of the financial crisis and is expected to remain lower than pre-crisis levels. Potential output is defined as the level of economic growth consistent with stable inflation. For advanced economies, the slowdown began in the early 2000s, when potential growth fell from 2.4 percent to 1.9 percent between 2001 and 2007. In emerging economies, potential growth during this period actually increased from 6.1 percent to 7.4 percent.
The study highlights how potential growth for all economies rest on the following three factors: employment growth, capital growth and productivity growth, which includes human capital growth. The financial crisis’ effect on these three factors differed for advanced and emerging economies. For advanced economies, the financial crisis meant lower employment levels (due to demographic changes), lower capital growth linked to decreased investment, and a short-term drop in total factor productivity. For emerging economies, total factor productivity suffered the most after the crisis—especially by those countries with higher foreign direct investment inflows from the United States—while employment growth was stable and capital growth actually increased.
Potential growth in advanced economies is expected to increase slightly, from an average of about 1.3 percent during 2008–14 to 1.6 percent during 2015–20, which is well below pre-crisis rates of 2.25 percent during 2001–07. In emerging market economies, potential growth is expected to decline further, from an average of about 6.5 percent during 2008–14 to 5.2 percent during 2015–20.
In order to combat these varied effects, the study suggests: “In advanced economies…policies and reforms that can increase supply should be adopted, such as product market reforms and higher spending on research and development, education, infrastructure, and policies to improve labor supply incentives. In emerging market economies, higher infrastructure spending is needed to remove critical bottlenecks, and structural reforms must be directed at business conditions, product markets, and education.”
The full report with economic forecasts for major countries will be released April 14, ahead of the World Bank-IMF Spring Meetings.