Dhaka, Bangladesh
Opportunities amid disorder: Europe and the world in 2018

Opportunities amid disorder: Europe and the world in 2018

(From yesterday's issue) Yet, there is a good chance that these already rosy forecasts still underestimate the momentum. For the first time since 2011, all major country groups are set for a robust, simultaneous upswing, with economic growth rates of at least around 2 percent. The US is already very far into its recovery, with unemployment lower than at any time since the early 2000s. Other regions have just embarked on recoveries or reached the point at which their recoveries have become self-sustaining. Latin America's largest economy, Brazil, is climbing out of its deepest recession in decades. Except for in Venezuela, there is for once no acute economic crisis festering in the region. In the euro area, a tepid recovery with unimpressive growth rates is turning into a fully fledged upswing as increases in domestic demand beget capital expenditure and consumption, further boosting this demand. China's economy has slowed marginally, but there is no reason to expect growth rates to drop dramatically from their current pace of around 6 percent. In comparable scenarios in the past, professional forecasters have often underestimated the self-sustaining momentum of the business cycle. It is likely that they are doing so again now - especially given that, since the crisis, observers have become accustomed to a dismal growth outlook in much of the world, including the euro area, and are thus reluctant to forecast the kind of growth rates experienced before 2008. At the end of 2017, there is little indication of purely economic tensions that could derail the global upward momentum. Monetary policy is still expansionary in the largest advanced economies. While the US Federal Reserve has started to tighten monetary policy somewhat and to slowly increase interest rates, most forecasters see interest rates remaining very low by historical standards in 2018. The European Central Bank has even hinted that, while phasing out its quantitative-easing programme over the coming year, it will wait until 2019 to raise interest rates. Inflation is still subdued and there are no signs of bottlenecks in the major economies or of a sudden jump in inflation. Austerity, which did so much damage to the European growth outlook earlier this decade, is a thing of the past. In the US and some important European countries, such as Germany, the political situation hints that 2018 will bring fiscal expansion even if their economies are already growing robustly. As austerity mostly weighed on the European economic outlook, the largest improvements are likely to be seen in the euro area. The eurozone architecture remains incomplete, with key euro members Germany, Italy, and France still in disagreement on how to complete the currency union. But the positive effects of the strengthening recovery now mostly conceal these problems - a rising tide hides all rocks. Strong nominal GDP growth means that debt-to-GDP ratios will soon fall. This growth, coupled with low interest rates, will allow more companies to continue to service, or resume servicing, their debt, which in turn will bring down the share of non-performing loans in banks' portfolios. With healthier balance sheets, banks are more likely to extend loans to the rest of the economy, further boosting the recovery. There remains the possibility that political upheaval will spill over into economics. For the euro area, the risk is that a political force fundamentally opposed to the common currency might gain power in a member state, triggering capital outflows and a return to a fully fledged euro crisis. Current polls in the countries most at risk in 2018 (especially Italy) predict that anti-euro parties will lack the support needed to form new populist governments. But polls have become increasingly unreliable in many countries in the past few years, so this risk should be monitored. In contrast, many political risks might be less significant than sceptics believe. For example, the possibility of a minority government, a dysfunctional coalition government or even repeat elections in Germany (Europe's current economic and political powerhouse) will only have limited downsides for the country's macroeconomic outlook. A developed country with an experienced army of civil servants can do fine economically without any party having a clear majority in parliament. Spain, after all, staged an impressive recovery from the euro-crisis recession during the first half of 2016, even as its political class struggled for months, in vain, to form a coalition government. Paradoxically, in Germany, a weak government might boost the economy in the short term. The caretaker government might implement a slightly expansionary fiscal policy to allow all coalition partners to realise some of their pet projects, fuelling the recovery in Germany and its neighbours. For Europe, another risk is a no-deal Brexit in which the United Kingdom leaves the EU in chaotic fashion. While it is true that Britain would suffer most in such a scenario, the country is a sufficiently important trading partner for the rest of the EU that the event would cause significant economic harm to the continent. However, even if such a scenario finally materialised, the EU would only feel the economic consequences after 2018. Both sides will continue negotiating for as long as possible to prevent such a scenario; companies will bet that European negotiators can come up with a creative way to prolong the deadline, as they have done at crucial moments in the past. For the rest of the world, a major, oft-mentioned political risk with macroeconomic consequences is that Donald Trump will try to whip up his base in the run-up to the midterm elections in November by implementing even more populist trade policies. One possibility is that he will follow through with his threat to pull the US out of the North American Free Trade Agreement (NAFTA), blaming his action on insufficient progress in talks to reform the deal with the Mexican and Canadian governments. As some of Trump's advisers have advocated, this might even serve as a prelude to a US withdrawal from the World Trade Organization's dispute-settlement system. Yet, while 2018 is set to be a good year economically, the smooth sailing will not continue forever. More economic risks are likely to materialise towards the end of the year. Going into 2019, the world's central banks will have to show how they manage the balancing act of slowly tightening monetary policy without strangulating the economy. But this will only become a serious issue in 2019. Until then, let's enjoy the good times as long as they last. 2. International security: a tough year ahead Good economic times in 2018 will probably focus attention on global security problems, which have deepened in recent years and show little sign of improvement. The fight against terrorism leads the list of concerns. Even though 2018 will see ISIS relinquish the remaining territory in its control, the fall of its so-called caliphate will not end the terrorist threat. Not only will ISIS activity likely continue to morph into an insurgency in both in Iraq and Syria, but the global terrorist threat will also evolve. Foreign fighters returning home may present new dangers. We may also see the emergence of new areas of operation or even a post-ISIS reorganisation of the jihadist galaxy. In any case, jihadist terrorist groups will remain active, and continue to attract recruits, in regions from the Sahel to south-east Asia. Although terrorism will persist in absorbing much international attention, inter-state tensions present a greater danger in 2018. Currently simmering crises - from the nuclear crisis in North Korea to the still-not-frozen conflict in Ukraine, to various conflicts in sub-Saharan Africa and the Middle East - may erupt into full-blown wars or humanitarian catastrophes. (To be continued)

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