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The global economic outlook as seen by the Caisse’s Chief Economist
Paul Fenton joined the Caisse as Chief Economist on May 9, 2011, with a mandate to establish its economic scenario, based on a vision of major macroeconomic trends on a three-year horizon. He talks to us about the global economic outlook for 2012 and 2013.
What are the main factors you are focusing on right now?
Right now we’re closely monitoring the situation in Europe because we believe it poses the greatest threat to the global economy. For two years, the euro zone has been in a sovereign-debt crisis of confidence because of the debt problems of various member countries, including Greece, Ireland, Portugal, Spain and Italy.
The crisis has become systemic. A vicious circle has set in, and the financial markets are becoming increasingly skeptical about the ability of these countries to repay their debt – hence the high risk premium on their bond rates, which is driving down the value of bonds issued by these countries. The consequences for Europe’s banking system are significant: because the banks hold a great deal of sovereign debt in their portfolios, their financing risks and costs are rising. They have no choice but to increase the interest rates on the loans they grant, which then affects the overall economy in the form of a decline in investment, consumer spending and government revenues.
The European crisis is so serious that the survival of the euro is even in question. The common currency seems to have come to a crossroads: it’s a make-or-break situation, you could say. We believe the euro will most likely survive the crisis because in our opinion the European Central Bank (ECB) will take the necessary measures to alleviate the situation.
Over the long term, the essential conditions to ensure the proper functioning of the euro zone and its viability involve greater economic and fiscal integration of the member countries. That’s the strategy espoused by Germany and France, which we think will be able to persuade the heavily indebted countries to commit to greater budgetary discipline and to adopt fiscal policies that are more sound and sustainable. Implicitly this means the ECB will have to play a bigger role in resolving the crisis.
But we are concerned that the process will take time, especially if it involves amendments to the European Union treaties. The Chancellor of Germany and the President of France have said they will do everything in their power to ensure the changes take place quickly. But there is a risk that the process will be long and cumbersome, especially if referendums are required by the national parliaments.
Come what may, even if the government succeeds in finding a credible solution to the debt crisis in the near future, we expect Europe to have a recession in 2012. We believe there are three possible scenarios: a moderate recession, a significant recession or a severe recession. The first two appear to be the most likely in our view.
The first scenario calls for a rapid agreement between the euro zone governments, which then make good on their promises of greater budgetary discipline. We believe the ECB would react in the right way; in other words it would adjust its strategy to reduce its key rate and increase bank financing, in addition to purchasing bonds on the secondary market.
The second scenario will occur if the governments are unable to agree on greater integration of their fiscal policies. A significant recession could result, which would require more vigorous intervention by the ECB. It would have to increase the volume of long-term bank financing. Lowering its key rate might not be enough. If Europe goes into recession and the rate of inflation decreases to a worrisome level, the ECB could be forced, for reasons of monetary policy, to introduce a major quantitative easing program to avoid deflation. Such action would lower bond interest rates for countries in difficulty, decreasing their financing costs and making their situation more sustainable. But even if disaster is averted as a result of all these efforts, Europe’s economic growth will remain weak for many years.
The third scenario, which we believe is the least likely, involves the spectre of a severe recession. In such a context, chaos throughout the European continent would spread to the rest of the world, and Italy might have to leave the euro zone. This outcome is so pessimistic, however, that we don’t believe Germany and France would allow it to happen.
What do you see unfolding in the United States?
The situation in the United States is looking more positive than it was a few months ago. The risk of a recession in 2012 seems to have been avoided, and we’re calling for weak growth, owing to modest domestic demand as households and governments alike deleverage. Public debt has reached a worrisome level, and the government will have no choice but to opt for an austerity budget. That will probably happen after the presidential election in November. Regardless of who is elected, the administration will have no choice but to tighten fiscal policy, which will happen in 2013. We believe the tightening will take place gradually over several years. We’re calling for a scenario of modest growth over a long period but we can’t totally rule out a more pronounced deterioration of U.S. economic activity in the event that a pessimistic scenario unfolds for the euro zone and leads to a severe recession.
Will emerging markets continue to stand out with their growth?
Emerging markets will fare well because they are reducing their dependence on exports to developed countries. Several of these countries, including China, have the financial capability to adopt expansionary economic policies. Moreover, trade between emerging markets continues to rise. These economies could record entirely acceptable growth rates even if they have to cope with a recession in Europe and weak growth in the United States. In such a context, they will not be able to prevent a slowing of global growth but they will at least cushion the blow.
What does the future hold for Québec and more generally Canada?
Commodity prices should remain firm even with a recession in Europe, as a result of sustained growth in emerging markets, which are now their main purchasers, as well as supply constraints. This encouraging outlook bodes well for the economies of Québec and Canada, which are major net exporters in this area. Moreover, as a result of their prudent economic and financial policies of recent years, Québec and Canada are in a good position to withstand the turbulence we’ll go through. We expect growth to slow in 2012 but pick up in 2013.
Two specialists enhance the Caisse’s economic expertise
In addition to extensive experience and a highly disciplined approach, Paul Fenton brings a global vision of macroeconomic and financial issues to the Caisse. He was formerly Chief of the Canadian Economic Analysis Department at the Bank of Canada, where he held various positions for more than 30 years, in addition to having worked for the International Monetary Fund. He is assisted by Yanick Desnoyers, who has an impressive track record of his own.
Mr. Desnoyers was previously Assistant Chief Economist at National Bank Financial Group and also spent several years at the Bank of Canada in the International Relations Department. Together, these two experts add depth to the knowledge and analytical capabilities of the Caisse’s team of economists.