The group of advanced countries enjoys smooth but low growth, with the United States being the exception (also smooth but substantially higher growth than the rest). But were the policies that produced this outcome as benign as often thought? Only the future can tell but worrying signs are mounting.
The financial press these days is full of sentences that start with or end with “…when the next downturn comes…”. The world economy and its financial system are these days so replete with disequilibria and anomalies that indeed the cardinal question is what will happen next when things get really awful – as they usually do in a downturn, a nice word for a recession.
Resilience on the Surface
The resilience of the world economy has recently been quite remarkable given the many adverse developments like, to name only the three most eye-catching ones, Trump’s trade war mongering and more generally the uncertainties created by his constant flip-flopping, mounting stress in financial markets and rising geopolitical tensions all over the globe. In its last World Economic Outlook, published a month ago, the IMF forecasts 3.2% real economic growth for the world economy this year. For 2026 the forecast stands at 3.1% and even for 2030 the same number pops up. After the deep Covid-19-induced contraction in 2020 ( -2.7%) and the sharp subsequent rebound ( +6.8% in 2021), the world economy gradually cruised toward that “just above 3%” number: 3.8% in 2022, 3.5% in 2023 and 3.3% in 2024.
Exactly the same pattern is visible for the advanced countries. The Covid- 19 recession was even worse with – 3.9% in 2020 followed by + 6.0% in 2021. Also the advanced countries seem to settle on a gentle cruise, although with nominally lower numbers: 3.0% real growth in 2022, 1.7% in 2023 and 1.8% in 2024. The longer-term future forecast oscillates around 1.6%, almost exactly half of the trend growth rate of the world economy. Striking differences are visible between the major blocks of the group of advanced countries. Over the period 2022-25 the United States enjoyed on average annual real economic growth of 2.7%, the euro area one of 1.5% and Japan 0.8%. The longer-term trend growth according to the IMF reflects these recent growth data with a forecast of 1.8% for the US, 1.1% for the euro area and 0.5% for Japan.
These at first sight relatively small differences in growth lead over the longer term to huge differences in the size of the economy. American GDP will reach in rounded numbers $30 trillion in 2025 and the euro area GDP $17 trillion, meaning that the American economy today is about 1.75 times larger than the euro area GDP. After growing during twenty years at 1.8% (US) respectively 1.1% (euro area) the gap between the two economies would widen spectacularly. By 2045 the US GDP would reach $43 trillion, the euro area GDP $21 trillion, meaning that the American economy would then be more than twice the size of the euro area economy.
From Status Quo to Big Bang
One really striking observation when looking more in detail at the growth numbers of the group of advanced countries is that taking out the exceptional Covid-19 years (2020 on the minus side and 2021 on the plus side) there has not been even a mild recession since the worst of the Great Financial Crisis was over by 2009. Over the decade between 2010 and 2019 annual real economic growth for the advanced economies group moved in a historically narrow band between 1.2% in 2012 (the worst year) and 2.5% in 2017 (the best year). We can add to this striking regularity the years 2023 till at least 2025 already.
It is all too often overlooked that such a narrow fluctuation band and more specifically the absence of something even remotely resembling a recession is historically most exceptional (the euro area economy contracted by 0.9% in 2012 and by 0.2% in 2013, still quite modest contractions given the magnitude of the sovereign debt crisis that battered the euro economy in those years). This smooth going of the advanced countries’ economy can lead as well to a positive sounding conclusion as to a more negative one. It could indeed be argued that these numbers show that we – political authorities and even more so central bankers – finally learned how to conquer the ravages of the business cycle. But there is also another interpretation to be given to the trend in these growth numbers, one that I believe to be of more value.
“There has not been even a mild recession since the worst of the Great Financial Crisis was over by 2009. Such a narrow fluctuation band, and the absence of anything even remotely resembling a recession, is historically most exceptional.”
The Cheap-Money Trap
The base line of the interpretation I prefer is that the policy mix that produced the growth trend described above was the result of two policy characteristics: on the one hand a persistent policy of cheap money through structurally accommodative monetary policies and on the other hand the bail out culture that came to dominate political decision making. In the shorter term these policy approaches lead to at least partial neutralization of the shocks that hit the economy. But, despite Keynes’ notorious words that “in the long run, we’re all dead”, there are longer term consequences of such interventions that we better start to recognize in full because they lead to disequilibria and anomalies that cannot go on forever.
The Productivity Freeze
Reflecting on these longer term consequences two categories can be distinguished, one related to the real economy and the other related to financial markets. With respect to the real economy the combination of cheap money and a general bail out culture produces a tendency towards status quo. Capital and labor remain stuck in existing companies and structures, certainly in the government sector. Renewal and productivity improving initiatives and investments are resisted. The process of creative destruction so crucial for a market economy to deliver on progress, and societal needs in general is increasingly obstructed.
The combination of cheap money and a general bail-out culture produces a tendency towards status quo.”
Zombies in the Marketplace
Some analysts have labelled this tendency to resist change the zombification of the economy. Zombie companies survive because only ultra-low interest rates allow them to honor their debt obligations and/or because a helping government hand is somehow always available. As a consequence of this desire to hold on to the status quo and the accompanying zombification of the economy, productivity stagnates, economic growth slows down, and job creation and income growth stall. Redistribution of income becomes ever more divisive and produces growing societal stress.
In financial markets prolonged periods characterized by cheap money and lack of significant shocks in the business cycle (to a large extent due to the status quo-reinforcing policy options) gradually lead to risk myopia. Investors increasingly focus on higher returns and gradually take the habit of minimizing the risks they are running in this process. Herd behavior in the investment community tends to generalize the myopic attitude. Inevitably bubbles start to get blown up. On top of this historical pattern in investment behavior, we have seen in recent times developments that have clouded the situation for regulators and market supervisors.
“ Zombie companies survive because only ultra-low interest rates allow them to honor their debt obligations and/or because a helping government hand is somehow always available.“
Shadow Finance Expands
After the Great Financial Crisis of 2008 political authorities and regulators all over the world took a close look at the banking sector that played such a crucial role in that major crisis. Consequently measures were taken to strengthen the robustness of the banking sector through, a.o., higher capital requirements and larger liquidity safety nets. As could be expected, the financial sector reacted to this new regulatory environment and private credit provision through hardly regulated so-called NBFIs (Non-Bank Financial Institutions) boomed. The uncertain monetary environment led to the launch of cryptocurrencies and more recently stablecoins. Numerous fintech startups came up with new risk assessment tools, improvements in payment systems and many other innovations. AI-inspired new developments are in the process of further fundamentally altering the financial landscape.
The Big Bang Risk Zone
It is difficult to disagree with Yao Zeng of the University of Pennsylvania Wharton School who recently claimed that “liquidity, credit, and payments – the core of the banking system – gravitated toward asset managers, tech platforms, and decentralized networks. This reshaping of finance itself now raises big questions.” One of those big questions is where in this new structure the major risks to financial and economic stability reside and what is the magnitude of those risks. The fact of the matter is that increasingly our regulators and market supervisors simply do not know the answer to such questions. Some degree of uncertainty in these matters is unavoidable but in recent times this degree of uncertainty has been on the rise in a highly significant way.
We have arrived, most certainly in the United States but also in Europe, in a situation where at any moment the tranquillity of the status-quo environment might be replaced with the chaos and anxiety of a Big Bang environment. When that moment comes, things develop usually much faster and much more disruptive than most of us thought possible.
“One of those big questions is where in this new structure the major risks to financial and economic stability reside and what is the magnitude of those risks. The fact of the matter is that increasingly our regulators and market supervisors simply do not know the answer to such questions.”
Johan Van Overtveldt 