“Brexit” marks the materialization of an important downside risk to global growth. The global outlook, set for a small upward revision prior to the U.K.’s referendum, has been revised downward modestly for 2016 and 2017, reflecting the expected macroeconomic consequences of a sizable increase in economic, political, and institutional uncertainty. But with “Brexit” still very much unfolding, more negative outcomes are a distinct possibility.
This setback comes against a background of already weak underlying growth caused by a combination of persistent and interlinked forces. These include: (i) the pre-crisis trend of slowing total factor productivity growth, compounded by population aging; (ii) the crisis legacy of debt overhang in advanced economies and rising corporate leverage and pockets of excess capacity in emerging economies; and (iii) the scarring of productive capacity, following the crisis, caused by persistent low investment and high unemployment. Not only is growth low, in many cases it has also been shared unequally. This can create more challenges by undermining support for reform as well as for openness to trade and migration.
Downside risks have become more salient, pointing to the critical importance of strong policies. Failure to achieve clarity about the future relationship between the U.K. and the European Union (E.U.) would add to uncertainty and weigh on confidence. This short-term risk could be severely heightened by a lack of decisive action to address the weakness in underlying growth. And, if not managed well, China’s transition could further raise volatility around the baseline path of the global economy. Against this background, insufficient rebuilding of policy buffers and tackling of corporate and financial weaknesses in emerging economies would leave them highly vulnerable to shocks.
A broad-based policy effort is urgent to contain risk and reinvigorate growth both in the short and the longer term,including:
Reducing uncertainty around “Brexit” and its repercussions. A smooth and predictable transition to a new relationship between the U.K. and E.U. that as much as possible preserves gains from trade is essential. While uncertainty about the outcome of negotiations remains, policymakers should stand ready to act decisively should financial market turbulence threaten the global outlook.
Implementing effective macroeconomic support. Where demand is still falling short, this requires a broad-based approach that exploits policy synergies by combining structural and balance sheet reforms with continued monetary support and growth-friendly fiscal policies—including using available fiscal space, anchored by strong policy frameworks. Stronger domestic demand support, especially in creditor countries with policy space, would also help reduce external imbalances.
Addressing debt overhangs. In many advanced economies, balance sheet repair remains critical tolift investment, contain vulnerabilities, and improve monetary transmission. Addressing corporate debt and other financial risks is also important in a number of emerging economies, and a key ingredient of China’s transition to a new growth model. In some cases, this might require the use of public sector resources.
Lifting long-term growth and making it more inclusive. The G-20 can lead by encouraging strong implementation of the G-20 growth strategies, and prioritizing structural reforms that have a high short-term growth impact.
Strengthening multilateral action. Reinvigorating trade integration remains crucial to boost global growth, as is making sure that the gains from trade are shared widely. And it remains important to strengthen global safety nets, including by monitoring geopolitical spillovers that could threaten the global recovery.
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