Guest Contribution: “New Year questions about the economic outlook”

Today, we present a guest post written by Jeffrey Frankel, Harpel Professor at Harvard’s Kennedy School of Government, and formerly a member of the White House Council of Economic Advisers.

Five questions about the international economic outlook, from Chosun Ilbo (the leading Korean newspaper), and my replies:

US president Trump and China’s president Xi agreed to a temporary ceasefire, in which the US suspended to impose higher tariffs on Chinese imports next year. How do you see the Trade War is going? How would it affect the global economy next year?

The trade war is not going well, for either the United States or its trading partners. It is good that President Trump, in his December 1 dinner meeting with President Xi in Buenos Aires, decided he would stop making things worse for the moment.  But the substantive outcome, at best, was that Trump postponed by 90 days the decision to raise to 25% his 10% tariffs on $200 billion of Chinese goods (and with it the expected Chinese retaliation). On March 1 we will be back where we were. The US side said the intervening time is to be spent negotiating to get China to accept its demands, including fundamental structural changes in its economic system. They will not agree to that.  China’s public statement after the Buenos Aires meeting bore very little resemblance to the US description, even regarding the items on the agenda.

Trump’s trade war is slowing down global trade in general. This will in turn contribute somewhat to the slowing of global economic growth in 2019.

US interest rates are climbing towards neutral for growth and inflation. How many times, do you predict, the Fed will raise the interest rates next year? How will the rates hikes impact on the global economy?

Prediction is hard.  Fed policy will depend on economic developments (“data dependence”).  Absent unexpected events, I would guess there will be two more interest rate hikes in 2019.

The Fed raised its policy rate to 2 ¼ – 2 ½ % on December 19. But the interest rate is still barely above the inflation rate, even though unemployment is down to 3.7 per cent (a 49-year low).  This is well below the interest rate that the Taylor Rule, for example, would call for.  Counter-cyclical policy calls for some further increases, even though that may not be a popular view.

Of course in any period when the US is raising interest rates there is the possibility that global investors will respond by pulling out of emerging markets. But if the Fed does continue its recent trend of raising interest rates it will be because US economic growth remains relatively strong, in which case it is not bad news for the world economy overall.

The US economy has been a world-growth engine this year. However, there are concerns whether its growth could be sustainable next year or not. What is your view on US economy for the coming year?

It is very likely that US growth will be slower in 2019 than it was in 2018.  The number one reason the US economic expansion was so strong this past year was artificial fiscal stimulus – such large tax cuts and increases in government spending as to produce budget deficits of a size that is very unusual when unemployment is so low.  It is especially unusual so late in an expansion.  But this “sugar high” (to follow the universal adoption of the phrase of Larry Summers) is expected to diminish in the coming year.  Moreover, other dysfunctionalities of life under the Trump presidency may also start to have serious economic costs, such as the misguided trade war and government shutdowns or debt-ceiling stand-offs.

It was probably inevitable that the Chinese economy would slow down after 2010, relative to the historic preceding three decades of growth averaging 10 per cent.  The question remains: hard landing versus softW

Many of the appropriate reforms had been identified by 2013 (at the Third Plenum of the 28thParty Congress): financial liberalization; structural shifts away from manufacturing toward services, and away from exports and heavy investment toward consumption; environmental clean-up; land reform and hukou reform; and a reduction in the role of inefficient state-owned enterprises, thereby giving dynamic private firms more room to grow.

While some of these reforms have begun over the last five years, others have not. In particular the trend seems now to be toward increasing the role of the state rather than shrinking it. The bad loan problem may eventually produce the feared hard landing.

What would be the most dangerous risk in global economy next year? US interest rates hike, China’s hard landing, Protectionism, Instability in emerging markets or anything else?

Protectionism and more general undermining of the liberal rules-based order are very serious threats for the long-term, but are unlikely to cause a recession in the short term.  The “euro crisis” is not really over, but will continue indefinitely; Italy is of particular concern.  The 2018 crises in Argentina and Turkey were and are serious; but financial markets seem better able to distinguish among EM countries now than in the 1990s.  Some EMs, especially those with dollar debts, are more vulnerable than others.

March 2019 is not only the deadline for a resumption of the US-China trade war. It is also the month when Brexit is to go into effect. Brexit will be an economic negative, especially if it takes place without alternative arrangements for UK-EU trade, as now seems very possible.  Such trade shocks are supply shocks, which monetary policy cannot protect against.

The possibility of a hard landing in China must rank as one of the top risks, especially from the standpoint of the Korean economy. 

Could Korea, an export leaning country, survive this environment? What kind of strategies should Korea take for the growth?

Two points.  First, the Korean economy remains excessively dependent on exports as a source of growth. Second, government measures to raise the minimum wage and cut the length of the workweek, however well-intentioned, are not the way to promote employment and income.  Labor markets should be flexible.

This post written by Jeffrey Frankel.

9 thoughts on “Guest Contribution: “New Year questions about the economic outlook”

  1. pgl

    I hammered Stephen Moore for lying about real wage growth in the Washington Times but it seems Michael Strain was doing the exact same thing at the National Review:

    https://www.nationalreview.com/corner/wages-will-keep-growing-in-2019/

    “Wages are growing. The most recent data on wages (more specifically, average hourly earnings) finds that they are up over 3 percent relative to one year prior.”

    Strain never mentioned that consumer prices rose by 2.2% during the same period. He did provide 3 graphs – all showing nominal wage increases.
    I do not want to accuse Strain of lying to the readers of the National Review. Maybe he like Stephen Moore flunked freshman economics. Inflation-adjusted? HELLO!

    Reply
  2. pgl

    Trump says there was a stock market ‘glitch’ in December, but it will rise when trade deals fixed

    https://www.cnbc.com/2019/01/02/trump-says-stocks-will-rise-once-trade-battle-settled-calls-last-months-market-decline-a-glitch.html

    I know everyone is having good fun with this glitch comment. It is really stupid. But Trump also lied about the stock market:

    “We had a little glitch in the stock market last month, but we’re still up about 30 percent from the time I got elected,” says Trump. “It’s going to go up once we settle trade issues and a couple of other things happen.”

    The S&P 500:

    https://fred.stlouisfed.org/series/SP500

    It closed at 2501 yesterday. It was 2163 when he was elected. Folks that is a 15% increase not 30%.

    OK – maybe Trump did lie. Maybe he flunked first grade arithmetic.

    Reply
    1. noneconomist

      Time for a “ME” comment…..from me. My own remaining stock (mutual ) funds are down 15% from their yearly highs. Obviously the work of scheming Democrats.
      Further proof: the Democrats in Silicon Valley (the Apple variety Democrats) purposely drove the Dow down 660 points today, continuing their not so covert efforts to embarrass the President and shake faith in the economy. The only way out of this mess is to build the wall. Now.
      It also would not hurt to lock up whichever Democrats are behind this attempt to tank the economy.

      Reply
      1. pgl

        “not so covert efforts to embarrass the President”.

        Just saying hello to the DONALD might embarrass him. We’re doomed!

        Reply
  3. pgl

    With all the talk about the FED tightening, it is interesting that the 10-year government bond rate has declined by 50 basis points in the last couple of months:

    https://fred.stlouisfed.org/series/DGS10

    Of course weak aggregate demand can lower interest rates. But Fearless Leader Donald THE Trump tells us that the economy is doing GREAT with the only problem is that tight monetary policy. What gives?!

    Reply
  4. Erik Poole

    “Protectionism and more general undermining of the liberal rules-based order are very serious threats for the long-term, but are unlikely to cause a recession in the short term. ”

    That is the key takeaway. Commodity price declines do appear to be forecasting a slowing economy in the long-term. Otherwise, US growth does seem destined to slow near term but not likely go into recession.

    Markets may have already oversold risks represented by Trump trade policy. Trump is unlikely at this point to complete his term. Once he is gone, investors will heave a sigh of relief and business confidence will quickly recover.

    The politicization of economic growth rates virtually guarantees that the Democrats will attempt to beat President Trump silly with off-the-press disappointing rates. That could mean that financial markets stay lower for longer. Blowback.

    Reply
  5. sherparick

    One should not underestimate how much Trump, and the Fox News Universe, gets high on their own supply. If you watched only Fox News and Fox Business News, read Fox Nation, Townhall, Redstate, and like web sites, or listen to Rush and like local and national talk radio, and treated MSM as a bunch of lies, you believed that President Obama had left the country a Sharia ruled wasteland and that Trump has liberated the country and “Made America Great Again” just with his magic “Business man presence.” Everything is the greatest ever, because Sean, Rush, Laura, and their ilk repeat the claim daily. Who needs evidence.

    It does freak me out that Trump and the rightwing talking heads don’t seem to understand the basic principal of tariffs being a tax on the consumers of the country imposing tariffs, that also create a “rent” that goes to the benefit of domestic producers of goods that can substitute for imports. So enjoy your 25% price increase on Chinese imported consumer goods in March.

    Reply
    1. noneconomist

      In whatever history they were supposed to study, they missed John C. Calhoun and the battle over the so-called Tariff of Abominations.
      Strange because the same right wingers mouthed lots of nullification nonsense during the Obama years.

      Reply
  6. Zi Zi

    Please look into Germany, Netherlands, Korea flow of capital and current accounts. Please dig into how Euro is being run and write about the root problems therein. I’m keenly looking for such writings, backed by numbers not generalities/principles-talking.

    Gold doesn’t go up; liquidity is being sucked up; — inflation is little likely to go up. Whether or by how much inflation goes up depends on how substitutable the imported goods are.

    Trump is doing all the jobs in the hideous way — shocking for the educated. But it remains to see whether he is destroying the system or actually trying to enforce the rules literally.

    Reply

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