Policy makers in fast-growing economies that are close to (or above) full capacity should be focusing on avoiding overheating, rebuilding fiscal and monetary conditions, and implementing structural reforms to allow their economies to sustain the fast growth. Managing macroeconomic policy is difficult at the best of times. For fast-growing economies—especially those that are having success in exploiting previously untapped potential—the challenge is particularly difficult because judging where an economy is relative to potential is daunting when domestic economic structures are rapidly changing and both foreign and domestic investors are expressing strong confidence in an economy’s future (box 5). While there are clear costs associated with overheating, especially when fast growth has been accompanied by rapid credit expansion, there are equally clear opportunity costs associated with prematurely slowing an economy and potentially forgoing fast growth and rising incomes.
For countries that combine rapid growth and already tight capacity conditions, the risks of overheating are higher; these risks include high or rising inflation or both (figure 14); growing current account deficits (as domestic supply is unable to meet rapidly rising demand); and asset price bubbles. In these economies, a tightening of either or both fiscal and monetary policy might be in order. That would be especially desirable in countries where monetary conditions have been relaxed in recent years, or where structural deficits are relatively high and the economy could therefore benefit from restoring some of the fiscal cushions that were expended in responding to the crisis.
Inflation tends to be higher in countries with limited spare capacity
Source: World Bank, Datastream
In China, ongoing rebalancing efforts remain a priority as does engineering a gradual decline in its unsustainably high investment rate. Should investments prove unprofitable, the servicing of existing loans could be come problematic — potentially sparking a sharp uptick in non-performing loans that could require state intervention (see World Bank 2013a, for more).