This progress is the result of policy improvements that have reduced the imbalances and fragilities that fed past boom-bust cycles; greater openness to international trade and deeper economic and financial integration; and, for commodity exporters, some good fortune in the form of strong prices. Nonetheless, while trend growth in the emerging market economies has substantially outpaced that in the mature economies, the emerging market economies generally continue to accelerate and decelerate in step with the mature economies. So much for decoupling. This continuing close correlation reflects the fact that stronger emerging market growth has been built upon deeper economic and financial integration with the mature economies...as well as with each other. Against that backdrop, spillovers from the mature economies clearly played a part in the recent slowdown across the emerging world. But something more appears to be going on as well. As a general matter, the emerging market economies appear to be operating closer to capacity than the mature economies. Emerging market economy labor markets generally look somewhat tight by historical standards, and while emerging market inflation is down, it is still an issue for a number of countries. This suggests that capacity constraints and structural issues have been playing a role in the recent sluggishness, and that somewhat slower growth may be part of the new normal for the emerging market economies as well. How much slower will in part depend on policy choices in the emerging market economies.
A big part of that reflects recent success in averting tail risks that were weighing on investor confidence. Europe’s common currency hasn’t fragmented, the U.S. didn’t go over its fiscal cliff, and China hasn’t had a hard landing. But in each of these cases, there is plenty of unfinished business, and important challenges remain. In the euro area, while there are grounds for cautious optimism, much remains to be done to restore confidence and growth. Fiscal adjustment is far from complete and is likely to continue to weigh on growth for some time to come. Financial conditions in the periphery have improved, but remain much less supportive than in the core. Plans to build a banking union and deepen economic, fiscal and political integration remain very much works in progress. And, as the elections in Italy have reminded us, there is an important political counterpart to the economic and financial challenges and risks confronting the region. In the U.S., we are only part way toward addressing our fiscal challenges. Recent measures are chipping away at the deficit, but the approach hardly corresponds to anybody’s ideal of efficiency. While there is little mystery about what ultimately needs to be done, we simply have not yet mustered the political will to make the compromises needed to get there. And, unfortunately, with deadlines coming – and one just having passed for decisions on mandatory spending cuts and spending and borrowing authorizations – we can’t be comfortable that this is going to go smoothly.