International Economic Update

World Economic Activity Picks Up
March 17, 2011

Global economic growth remained strong in fourth quarter 2010 and into this year. In advanced economies, slack is beginning to lessen as evidenced by falling unemployment rates and increasing inflation. Rising commodity prices are the main risk to global growth. High food prices are causing inflationary concerns to build among emerging economies.

Revised Global Measure Expected

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An aggregate measure of expansion among the world's eight major economies declined slightly during the fourth quarter (Chart 1).[1] However, recent economic activity points to more robust global growth and suggests these numbers will be revised upward. World trade data show vigorous activity persisted through December, with emerging economies leading the global recovery (Chart 2).

Emerging Economies Show Strength

Emerging economies continue surpassing the advanced economies in performance and have attracted capital inflows in response to the growth differential. Gross domestic product (GDP) growth highlights uneven performance between advanced and emerging economies. In the fourth quarter, GDP expanded 5 percent from the year before in Brazil, 6.9 percent in Indonesia, 9.7 percent in India and 9.8 percent in China. By comparison, GDP grew 2.7 percent in the U.S., 3.2 percent in Canada, 2.5 percent in Japan, 2 percent in the euro area and 1.5 percent in the U.K. (Chart 3).

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Slack in Advanced Economies Lessens

Contributing to the growth differential is slack in advanced economies, as relatively high unemployment rates indicate. However, recent evidence shows unemployment is starting to decline, though still remaining elevated, amid heightened economic activity. The U.S. jobless rate fell to 8.9 percent in February, the lowest in 22 months (Chart 4). Unemployment rates in the euro area leveled off in 2010 and ticked down in January. Canada's unemployment rate rose slightly to 7.8 percent in January, but down from the peak of 8.7 percent in August 2009. Another sign of reduced slack is a pickup in inflation in advanced economies.

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Inflation Catches Monetary Authorities' Attention

Inflation has been paced by rising commodity prices, with monetary authorities stating that they will take necessary action to maintain long-term price stability and prevent a buildup of inflationary expectations. Thus far, no policy changes have been undertaken. Inflationary pressures in emerging economies have been elevated for some time (Chart 5).

With rapid GDP growth and large capital inflows in the emerging economies, inflation worries are rising, prompting tightening monetary policy. India raised its benchmark rate in January, followed by Indonesia in February and Brazil in March. China utilized two inflationary controls in February, raising its primary policy rate and increasing bank reserve requirements.

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Rising food prices in emerging economies tend to keep inflation at elevated levels. Because food represents a much larger portion of consumer expenditure, the sector has an amplified effect on inflation. With food prices in the emerging economies driven mostly by supply factors, export bans are being extended and highly demanded products are being hoarded. In response, emerging economies are using alternative inflation controls to combat rising commodity prices. Indonesian residents have been urged to plant chilies to increase supply, for example.

Global Economy Gaining Strength

Overall, the global economy is gaining strength, with trade flows indicating a rebound from the Great Recession. Japan's economy has suffered from recent earthquake, tsunami and nuclear power plant disasters, which will dampen global growth. However, the strong performance of other economies should offset the resulting losses. Overall growth prospects for 2011 are likely to be revised higher. As commodity prices rise, monetary policy in emerging economies is beginning to tighten to address inflationary concerns. There is no evidence suggesting rising commodity prices have led to higher price expectations in the advanced economies, where authorities are prepared to react if that occurs.

—Adrienne Mack