Every policy decision that can lay the foundations for a new Global Financial Crisis will now be taken

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The World Bank issued its new year economic outlook yesterday, saying:

The World Bank forecasts global economic growth to edge up to 3.1 percent in 2018 after a much stronger-than-expected 2017, as the recovery in investment, manufacturing, and trade continues. Growth in advanced economies is expected to moderate slightly to 2.2 percent in 2018, as central banks gradually remove their post-crisis accommodation and the upturn in investment growth stabilizes. Growth in emerging market and developing economies as a whole is projected to strengthen to 4.5 percent in 2018, as activity in commodity exporters continues to recover amid firming prices.

Their Global Outlook was:

A broad-based cyclical global recovery is underway, aided by a rebound in investment and trade, against the backdrop of benign financing conditions, generally accommodative policies, improved confidence, and the dissipating impact of the earlier commodity price collapse. Global growth is expected to be sustained over the next couple of years–and even accelerate somewhat in emerging market and developing economies (EMDEs) thanks to a rebound in commodity exporters. Although near-term growth could surprise on the upside, the global outlook is still subject to substantial downside risks, including the possibility of financial stress, increased protectionism, and rising geopolitical tensions. Particularly worrying are longer-term risks and challenges associated with subdued productivity and potential growth. With output gaps closing or already closed in many countries, supporting aggregate demand with the use of cyclical policies is becoming less of a priority. Focus should now turn to the structural policies needed to boost potential growth and living standards.

It's also worth noting their regional perspective:

Growth in most EMDE regions with large numbers of commodity exporters recovered in 2017, with the notable exception of the Middle East and North Africa, mainly due to oil production cuts. These regions are generally expected to see faster growth during the forecast horizon, as commodity prices rise and the impact of the earlier terms of trade shock diminishes. e robust pace of expansion in EMDE regions with a substantial number of commodity importers is expected to continue. Risks to the outlook have become more balanced in some regions, but continue to tilt down in all of them. is edition of Global Economic Prospects includes a chapter on the sources of slowing global potential growth and policy options to raise it, as well as two special focus pieces–on the impact of the 2014-16 oil price collapse and the potential implications of improving education for inequality.

So what does that mean? According to the FT it is this:

Global growth appears to have peaked, with demographics, a lack of investment, a slowing in productivity gains and tightening monetary policy placing limits on economic expansion, the World Bank said.

The world’s economic output grew 3 per cent last year as more than half of economies accelerated, thanks to a rebound in investment, manufacturing activity and trade, bank economists said. The global economy is expected to maintain that rough growth level through 2020.

But that may be as good as it gets, according to the bank’s annual report on the state of the global economy. The problem facing the world is that after years of recovery from the 2008 financial crisis, most advanced and developing economies have closed the output gap between actual and potential economic growth.

Moreover, it is hard to see that changing unless governments embrace the sort of reforms and investment drives that the bank and other institutions have been demanding for years.

Larry Elliott in the Guardian has another spin:

Financial markets are complacent about the risks of sharply higher interest rates that could be triggered by better than expected growth in the global economy this year, the World Bank has warned.

The Washington-based organisation said that much of the rich west was running at full capacity as a result of a broad-based upswing in activity, but were now vulnerable to a period of rising inflation that would prompt action from central banks.

Launching the Bank’s global economic prospects, the lead author Franziska Ohnsorge said: “There could be faster than expected inflation that would mean faster than expected interest rate hikes.”

So what does all this mean?

First, forecasts can be wrong: the World Bank may be incorrect here.

Second, as Martin Wolf said yesterday, it takes some believing that the world economy can 'hum' as global politics 'sours'.  The World Bank hint at the same problem.

Third,  if the World Bank is to be believed, the next global downturn is postponed, yet again.  These things happen, on average, about once every 7 to 8 years: we're already due one, but not yet if the World Bank is right.

Fourth, the  downturn is not cancelled, it is merely postponed.

Fifth,  the only way that the postponement can be prolonged is by increasing investment in infrastructure and training whilst introducing measures to tackle inequality.

Sixth,  whether those measures are introduced or not there will, in the short term,  be growth. As a result, in some countries at least, inflationary pressure  is likely to  result in an increase in  interest rates.  Indeed, as the FT reported this morning,  that trend is already hitting markets:

US government bonds steadied on Wednesday following a sell-off triggered by the Japanese central bank’s decision on Tuesday to trim long bond purchases.

Yields on 10-year US Treasuries, which move inversely to price, were flat at 2.549 per cent after hitting a 10-month high a day earlier. Those on the Australian equivalent were up 5 basis points at 2.722 per cent as selling of Australian government bonds caught up with their US counterparts.

The moves came after the Bank of Japan said it would scale back its monthly bond purchases, putting investor focus firmly back on the outlook for global central bank policy.

What's the consequence of all that? I would suggest that it is the risk of an unholy mess.

Short-term growth will boost the populists:  they will claim that their policies are working.

Interest rates will be increased:  the pressure on vast numbers of debt stressed households will reduce their disposable income, and force many into real poverty, and loss of their homes, or bankruptcy.  The foundations for a new banking crisis will be laid.

Interest-rate rises will discourage the already incredibly weak level of private sector investment.  The World Bank's hopes for any reform from this source will be dashed.

The wealthy  and their bankers will be delighted at  what will look like the  beginning of the return to 'normal times' i.e.  those that prevailed before 2008.

Right wing governments  will say that their increased borrowing cost requires enhanced austerity, and will refuse as a result to make the investment that the World Bank thinks necessary in infrastructure, training and tackling inequality.

As a consequence inequality will rise.

As a consequence populism will be fuelled.

The consequence of that is anyone's guess.

The foundations for a new downturn will, undoubtedly, be laid.

And all of this is unnecessary. It will happen  because economists, and Treasuries, still think that the way to manage the economy is through the manipulation of interest rates to control inflation. This, however, is wrong.

Interest rate policy is designed to enforce increased savings.  This impacts inflation by reducing demand. However, when the world already has a glut of savings, albeit from those with wealth, there is no need for them to save more: the wealth imbalances that these savings create is already a massive problem. Increasing that problem by encouraging more saving is clearly counter-productive.

But also note that interest-rate increases also increase savings by increasing the  interest payments due by those with borrowings.  This has greatest impact on those without savings: for them the only ways in which the increased interest increase cost can be paid  is by either cutting consumption, or by increasing their borrowing.  When most of these people are, already, barely making ends meet and have suffered low or no pay rises for an exceptionally long period cutting spending will be very hard to do. Increased borrowing  simply lays the foundation for a future financial crisis:  this is a fact already widely recognised.

And at the same time,  the increase in interest rate will discourage government spending, albeit  for entirely false reasons, and will discourage  what little private sector investment  there already is.

As a consequence if Larry Elliott is right as to the reaction to the World Bank's forecasts (and presuming that the World Bank is right, then I think that he probably is) then the next three years will be the equivalent of 2004 to 2007: every policy decision that can be got wrong to lay the foundations for a new Global Financial Crisis will be taken.

And the alternative is? Governments need to spend more: that is quite explicitly what the World Bank is saying.

And governments will need to tax more,  because that is the alternative way of taking demand out of the economy to tackle inflation,  even though it seems that Treasuries have forgotten just what fiscal policy is all about.

And who should be taxed more? That's obvious:  It is the corporations with taxpayers;  the wealthy sitting on savings;  the higher income earners who can more than readily make ends meet;  large property owners who  have profited enormously from real estate inflation; and it is  those who have benefited from the growth in financial transactions which have hyped asset prices beyond any reasonable level.  It so happens that in each case that is where the inflation is within the system: it is not in ordinary household wages that this phenomenon will be seen. And that is precisely why fiscal policy linked to specific targeting of measures to tackle the actual inflation that exists is required.

But I won't hold my breath. Treasuries around the world will take us back to the old times. And the one thing we know about them is that from 1980 to date they have got most things wrong.