NEW YORK – Since the beginning of the year, the world economy has faced a new bout of severe financial market volatility, marked by sharply falling prices for equities and other risky assets. A variety of factors are at work: concerns about a hard landing for the Chinese economy; worries that growth in the United States is faltering at a time when the Fed has begun raising interest rates; fears of escalating Saudi-Iranian conflict; and signs – most notably plummeting oil and commodity prices – of severe weakness in global demand.
And there’s more. The fall in oil prices – together with market illiquidity, the rise in the leverage of US energy firms and that of energy firms and fragile sovereigns in oil-exporting economies – is stoking fears of serious credit events (defaults) and systemic crisis in credit markets. And then there are the seemingly never-ending worries about Europe, with a British exit (Brexit) from the European Union becoming more likely, while populist parties of the right and the left gain ground across the continent.
These risks are being magnified by some grim medium-term trends implying pervasive mediocre growth. Indeed, the world economy in 2016 will continue to be characterized by a New Abnormal in terms of output, economic policies, inflation, and the behavior of key asset prices and financial markets.
So what, exactly, is it that makes today’s global economy abnormal?
First, potential growth in developed and emerging countries has fallen because of the burden of high private and public debts, rapid aging (which implies higher savings and lower investment), and a variety of uncertainties holding back capital spending. Moreover, many technological innovations have not translated into higher productivity growth, the pace of structural reforms remains slow, and protracted cyclical stagnation has eroded the skills base and that of physical capital.
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