Tightening of monetary policies in most industrial countries and several emerging-market countries generally appears likely to be sufficient to keep inflation reasonably in check, although there are some countries where further policy efforts are likely to be needed and where output growth may need to slow.
While global growth prospects continue to look reasonably good and global inflation appears likely to remain generally well contained, risks to global economic performance are greater than in recent years.
In this regard, the risks that have received greatest attention recently are those potentially arising from the turbulence in global financial markets that started in late July due initially to concerns about financial instruments embodying claims on subprime mortgages in the United States.
These concerns then spread to a much wider class of short-term financial instruments and had significant repercussions in financial markets in both Europe and the United States (including some spillover to markets for credits of emerging-market countries).
In my view, it was appropriate for major central banks to respond to the turmoil with injections of credit and some modest reductions in policy interest rates. When important credit markets begin to cease to function normally, there is always a danger that the crisis may deepen and the real economy may feel significant adverse effects. It is wise to take moderate precautions to help assure that this process does not get out of hand.
However, it is important to be careful not to exaggerate the likely economic effects of financial-market turbulence. In my 25 years of forecasting the US economy, the worst mistake I ever made was in late 1998.
The global financial-market turbulence following Russia's default and the collapse of the hedge fund Long Term Capital Management had created worries of severe economic fallout, even with actions taken by major central banks to calm the markets. Sharing these concerns, in late 1998, I was instrumental in persuading colleagues at the International Monetary Fund (IMF) to reduce the forecast for US economic growth in 1999 to 1.8 percent. The actual outcome was growth of 4.2 percent!
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Peterson Institute for International Economics
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