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Most regions of the world will see slower growth and faster inflation in 2008.
After a four-year boom, the world economy is entering a more difficult period in which growth in almost every region is set to decelerate. At the same time, inflation has picked up around world.
Although the U.S. recession is likely to be short and shallow, the recovery will probably be quite weak.
First-quarterU.S. economic growth is likely to have been barely in positive territory. Second-quarter growth will probably be decisively negative. It is believed that the promised tax rebates will return growth to positive territory during the second half of the year. Nevertheless, the economy is likely to weaken again by the beginning of 2009, with a30% chance of a double-dip.
The rest of the world will not be able to shrug off the U.S. problems.
There are many transmission mechanisms of aU.S. recession to the rest of the world. The most obvious are the direct trade linkages. These direct trade linkages understatethe true trade vulnerability because of the increasing importance of global supply chains. A second transmissionchannel of the U.S. "shock" to the rest of the world is exchange rates. Other ways in which the U.S. crisis has been feltworldwide include stock markets, the ripple effects of the subprime crisis, and the impact on the profits and investmentsof European and Asian multinational corporations with heavy exposure to the U.S. economy.
European growth is slowing-the only question is how much.
Eurozone growth this year and next year to be 1.4% and 1.6%, respectively. A number of countries at Europe's periphery are at high risk of afinancial crisis, including the Baltic states, Bulgaria, and Iceland. Equally troublesome is the prospect of near-zero growth in Italy this year, and a sharp deceleration in Spain.
Asia has not decoupled from the developed economies, but should be able to avoid a nasty scenario, unless China'seconomy stumbles.
The region is in much better shape to weather the current economic slowdown than it has been in acouple of decades. Unfortunately, all the Asian economies are still too dependent on exports to the United States andEurope. In fact, exports as a share of regional GDP have risen more or less steadily over the past decade.
The risk of stagflation is still relatively low.
On the other hand, if oil prices continued to surge, averaging US$150 abarrel in 2008, then the world economy would likely suffer through a recession and inflation in the low double digits.Such a scenario could legitimately be called stagflation.
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