If America's economy runs hot, what happens to the rest of the world?
When america sneezes, the rest of the world catches a cold. But what happens when it runs a fever? After a trying 2020 in which GDP fell by 3.5%, America is poised to enjoy a robust rebound in 2021 simply by returning to something like normal as vaccination proceeds. Yet it might manage more than just that. If President Joe Biden's covid-19 relief bill is enacted, total stimulus this year may exceed $2.5trn. That could easily push output above what the Congressional Budget Office estimates to be its "potential" level: that is, the amount the economy can produce without an increase in inflationary pressure. This possibility has some American economists on the lookout for signs of accelerating growth in prices and wages. America does not operate in a vacuum, however; should overheating occur, its effects will not be con- fined within its borders. Depending on how the recovery plays out, a hot American economy could be a boon for the rest of the world—or yet another source of concern.
In a closed economy that does not trade with the rest of the world, too little spending leads to job losses and downward pressure on prices, whereas too much should push up employment and, eventually, prices. In an open economy, however, some of the effects of the shifts in demand spill over to the rest of the world. A sharp drop in spending, for instance, may be associated with plunging demand for imports, in which case some of the pain of a slump is exported abroad. During the global financial crisis of 2007-09, troubles in financial markets wreaked havoc all over the world, but even countries relatively insulated from those woes felt a chill thanks to trade links with America and Europe. According to one estimate, about a quarter of the drop in American demand and a fifth of the fall in European demand was borne by other economies, and transmitted through trade.
A boost to demand ought to work in a similar way, but in the other direction. As Americans spend more, some of it leaks abroad: through purchases of foreign goods, for example, or spending on services—including tourism, which should begin to rebound as pandemic restrictions are lifted. An analysis of fiscalpolicy spillovers published by the IMF in 2017 found that an American stimulus consisting mostly of spending (as opposed to tax cuts) and worth 1% of GDP raises the output of the average country by 0.33% in the first year. Countries with closer trade ties experience bigger effects; the fillip to Canada's economy is estimated to be almost three times the average, for example. If the combination of reopening and stimulus invigorates the American consumer, the effects could quickly be felt all over the world.