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Forward Thinking Magazine : August 2010
21 economic commentary By Richard Gibbs, Global Head of Economics, Macquarie Research In many cases these countries have already experienced a pull-back in extraordinary policy settings be it explicitly, as is the case in China and Australia, or implicitly via stronger exchange rates in much of Asia. The second group of countries are still experiencing the peak of the cyclical upswing and still have considerable headroom to grow without overheating. A large proportion of the global economy is in this group, including the US, India, New Zealand, Brazil and the core European economies. Finally, the European periphery and the UK are likely to experience below-potential growth. This group of laggards is defined by sovereign debt concerns leading to aggressive fiscal consolidation, while the fall in domestic currencies is likely to have only a muted impact on the smaller, or more troubled, export sectors of these economies. In terms of the emerging profile of economic activity, it is apparent that the fortunes of individual economies and their relative economic standing will be largely driven by the strength of domestic demand. Needless to say, those economies that are best placed to support expanding demand will be at the forefront of the global business cycle and those that are burdened by excessive levels of public debt will be the laggards through this cycle. Measures aimed at fiscal consolidation will need to be carefully structured, particularly in the UK, Greece, Spain and Ireland so as to balance the need for deficit and debt reduction with sustaining some level of economic expansion. The emergence of the three-speed global economy A clear lesson from the experience of Japan during the ‘lost decade’ was that ill-timed and poorly structured fiscal consolidation measures imperil economic activity, leading to protracted periods of stagnation. Therefore, it is likely that economies that opt for a medium term programme of fiscal consolidation will achieve better growth outcomes than those that are driven by hasty and highly politicised policy announcements. Moreover, we should expect that a disproportionate amount of the burden of supporting aggregate demand in the most highly indebted economies will fall to monetary policy. For investors, the extent of the dispersion in the global business cycle will be largely determined by the actions of the respective policymakers and their capacity to mitigate against sovereign and broader macroeconomic risk. For example, in the UK and Euro area economies the current focus on rapid fiscal consolidation will need to be balanced against the risks of protracted economic stagnation. Overall the combination of greater dispersion on the global business cycle and shorter sharper cycles suggests that investment markets will need to remain alert to sporadic bouts of risk aversion, a renewed focus on sovereign risk, greater variability in macro policy settings and higher average costs of capital.