Risks exist amid divergent monetary stances: US economist

A major risk in the global economy is the divergent monetary stances by major economies, which will likely continue for the next few years, an economist has said.

The euro area and Japan will go on with aggressive monetary easing to boost weak demand, while the U.S. is set to raise its interest rates, David Stockton, a senior fellow at the Peterson Institute for International Economics and former head of the Federal Reserve's economic research division, told Xinhua in a recent interview.

Meanwhile, the recent appreciation of the U.S. dollar and the depreciation of the Japanese yen and the euro are likely to continue, because the U.S. economy is going to continue outperforming those economies, he said.

The global economy is going to face a subdued inflation environment next year, in view of the weakening growth and falling oil prices, the expert noted.

The substantial decline in oil prices will hold down headline inflation in many economies, where the inflation rates have been running below their central banks' targets. But this kind of low inflation was not the primary concern for the world economy, as the downward pressure will likely prove to be transitory, said Stockton.

The lower oil prices are expected to significantly boost economies that are major oil importers, and the boost to the economies that consume energy is bigger than the hit to the economies that produce oil, said the expert.

On the other hand, low inflation resulted from weak economy is a big worry. There is considerable uncertainty about the strength of the euro zone and Japanese economies; growth in some of the emerging market economies are also slowing. Even in the U.S., despite the improvement in the labor market, there is no sign of upward pressure on inflation, given that the appreciation of the U.S. dollar keeps import prices low, and substantial decline in oil prices also weigh down on the price level, he said.

"That's the reason why, especially in advanced economies, policymakers need to do something to boost inflation back toward their targets. As the Japanese economy showed, once you stuck in deflation area, it's hard to actually break out of that," said Stockton.

The most important tool to shake off low inflation is to continue aggressive monetary policy expansion, according to the expert. Although the European Central Bank has been slow on aggressive monetary policy, it might begin to act more like the Fed and the Bank of England, and more recently like the Bank of Japan, to boost inflation, said the expert.

As for the Fed, the U.S. central bank will probably begin to raise interest rates around the middle of 2015, but the monetary policy normalization will proceed at a slower pace than what market expected, said Stockton.

A change in the world's largest economy's monetary policy might bring volatility and turmoil to the financial markets, like the "taper tantrum" in the summer of 2013. The risk to see reversal of capital flows in the global economy will likely to continue, he said. Many emerging market economies have depended on cheap capital inflows, as the Fed has kept the very low interest rates for a very long period.

In order to keep the potential risk from becoming a serious global development, the Fed is going to move very slowly and more predictably, and communicate reasonably and clearly with the market, said Stockton, who is optimistic about the impact from the Fed's tightening.

"I don't think we are going to see any abrupt stop of reversal of capital flows," he said.

It is likely that the Fed will raise the interest rate before the U.S. inflation begins to pick up, as Chair Janet Yellen expressed her confidence that the inflation will come back to the Fed target despite the low level now.

In regard to the impact on China, the expert said that China is in a better position to withstand the Fed's reversal of policy and would be less affected by the divergent performance of monetary policy stances.

As for the worries that the Fed's interest rate hike might weigh further down on inflation level, the expert said one of the major factors the Fed will take into account in its process of raising rates is the inflation condition in the U.S.

In this process, the Fed does take into consideration of global activities and global inflation that to some extent will affect the U.S. economy, but they are not the independent factor, said the expert.

Beyond the economic risks, the rising geopolitical tensions are going to weigh on the world economy next year, said Stockton. Tensions between Ukraine and Russia will to some extent pose risks to the European economy, while its impact on other economies, such as the U.S., will remain limited, said Stockton.