The IMF’s new forecast for the world economy calls for 4.8% growth for all of 2010, or slightly higher from the July prediction. The outlook for the U.S. economy, however, was revised down for this year: 2.6% vs. the summer forecast of 3.3%.
“The world economic recovery is proceeding,” IMF Chief Economist Olivier Blanchard explained in a press conference. “But it is an unbalanced recovery, sluggish in advanced countries, much stronger in emerging and developing countries.”
Same old, same old. But the difference now is that the Federal Reserve is mounting a stronger monetary response than it was during the summer. In essence, the central bank is trying to juice the economy by raising inflation expectations and thereby boost nominal GDP growth. Will it work? We’ll find out soon enough, but this much is clear: various corners of the market are inclined to see inflation rising. It’s only a marginal change from recent history, but it seems to building a head of steam. The first half of the strategy seems to be working. It’s the second half that’s the key, though, but figuring out if that’s coming as well will take time.
Meanwhile, it looks like inflation expectations are on the rise. Exhibit A is the price of gold, which continues to run higher and is closing in on $1360/oz. Higher gold prices generally translate into a weaker dollar, and this time is no exception. The U.S. Dollar Index continues to weaken and is nearing its low point for the year. Unsurprisingly, the whiff of higher inflation has also elevated commodity prices generally. The S&P GSCI Index, for instance, is now trading at its highest level this year, due in no small part to the rising price of oil.
Of course, the bond market is responding too. The inflation forecast, based on the yield spread between the nominal and inflation-indexed 10-year Treasuries, inched up again yesterday, settling at 1.89%, the highest since June.
What’s extraordinary about the market’s rising inflation outlook is that it’s accompanied, at least for the moment, by a falling yield on the benchmark 10-year Treasury, which fell to 2.41% yesterday, based on Treasury data. That’s the lowest since the depths of the 2008 financial crisis, when the 10-year yield hovered just above 2.0% at one point.
In short, the final act in the great reflation trade is in full swing. But if you’re expecting a consensus among economists on whether this works, or not, you’re expecting too much. Scott Sumner, for example, has been arguing for some time that monetary policy still has traction. Not everyone agrees. In fact, some dismal scientists see nothing but trouble ahead. Joseph Stiglitz estimates the odds of success for additional monetary stimulus at the zero bound is, well, zero, he writes.
From the Great Moderation to the Great Recession to the Great Reflation and now the Great Experiment in a few short years. Macroeconomics may be headed for a major rewrite (or not?). Details to follow.