Real growth has been weak in the aftermath of the global financial crisis, particularly in the advanced economies, which were at the center of it. This was to be expected given the history of recoveries following deep financial crises. Somewhat less clear, however, was how inflation would behave amid unprecedented monetary easing measures by core central banks.
Some observers feared inflation might surge as a result, but these fears proved unfounded (at least in advanced economies) and ‘low-flation’ has become the more pressing concern: euro area inflation is printing dangerously close to zero, Chinese inflation has been surprising on the downside, the sustainability of Japan’s inflation revival remains in question and, even in the US and the UK, inflation has been somewhat tamer than labor market developments would suggest. Although trends are not uniform, inflation remains subdued on a global basis, with the exception of a few EM economies, excluding China.
Low real growth combined with low inflation means recent nominal GDP growth rates in advanced economies have been significantly lower than in the decade before the global financial crisis erupted. (Figure 1) At the same time, one nominal ratio has been rising rapidly: public debt to GDP.
Among advanced economies, this ratio has surged since 2007, as governments have taken on debt in the wake of the financial crisis (note, the inflection point for public debt to GDP was in the mid-1970s and it accelerated in the late 1980s and the 1990s). Public debt in advanced economies now stands at around 100% of GDP (as a PPP-weighted average), the highest in roughly a century, barring a spike in World War II:
Source: IMF (WP/14/162); Barclays Research; based on data for 13 advanced economies: Australia, Belgium, Canada, France, Germany, Ireland, Italy, Japan, Netherlands, Spain, Sweden, UK, and US.
Historically high debt-to-GDP ratios combined with historically low nominal GDP growth put policymakers in a tough spot. Until growth and/or inflation returns, they must try to keep nominal interest rates low to keep the real interest rate burden manageable. This constraint may be one reason why so many investors still feel comfortable holding public debt in core markets, which in turn contains the rise in longer-tem yields.
This helps to explain the parallel performance of bond and equity markets and sheds light on why the much-anticipated ‘great rotation’ has so far been quite subdued. In the same vein, high debt/GDP ratios and low nominal growth in core economies also dampen fears of capital flow reversals from EM debt markets stemming from rapid increases in core interest rates.
Higher nominal yields on EM government debt (combined with generally much lower public debt to GDP ratios) remain an attractive offer when core market policymakers need to contain nominal interest rates in the face of debt sustainability concerns. The return of inflation could change all this, but for now it seems advanced economies will continue to face unpleasant nominal realities for some time.
Source: Haver Analytics, Barclays Research