Hamish McRae: The cost of the black stuff shouldn't sabotage recovery but we could slip up on cheap cash

Spring was in the air in Paris last week at the OECD's annual forum. Instead of the gloom, or at least concern, of recent years, there was a bright glow. This year will be the best for global growth for four years and next will be pretty good too. The new, upgraded, Economic Outlook forecasts were unveiled and Jean-Philippe Cotis, the organisation's chief economist, described the recovery as "strong and sustainable". While he noted the extent to which it had largely bypassed continental Europe, he said economists see good reasons to expect a more evenly shared recovery in the period ahead.

Spring was in the air in Paris last week at the OECD's annual forum. Instead of the gloom, or at least concern, of recent years, there was a bright glow. This year will be the best for global growth for four years and next will be pretty good too. The new, upgraded, Economic Outlook forecasts were unveiled and Jean-Philippe Cotis, the organisation's chief economist, described the recovery as "strong and sustainable". While he noted the extent to which it had largely bypassed continental Europe, he said economists see good reasons to expect a more evenly shared recovery in the period ahead.

It is worth just noting this relative success. People are tetchy here in Britain, worrying about the dependence on the housing market. They are worried in the US - or at least they should be worried - by the scale of the fiscal deficit and the balance of payments one. On the Continent, consumer demand remains stagnant in most countries, while even in Japan, which seems at last to have escaped from its decade of stagnation, doubts remain about the durability of its recent growth. More generally, some observers worry about the sustainability of the Chinese economic boom and the threat of rising oil prices.

It is quite proper to be concerned about the economic risks ahead. But it is important not to let those risks cloud one's judgement about what is being achieved at the moment. The new OECD forecasts for the five largest economies are shown in the left-hand graph. In every case, this year will be better than last, and 2005 is forecast to be pretty good too.

One concern is that the price of energy could become a drag on growth as, in nominal terms, oil is as expensive as it has ever been: Brent crude was above $39 a barrel last week. But in real terms, oil is still cheaper than it was in the early 1980s (see right-hand graph). True, it is at the top of its range for the last two decades, and true, the rise in energy prices is coming unusually early in the economic cycle. The point is that while more expensive energy takes demand out of the world economy, the present level is acceptable.

An early rise in energy prices is largely the result of demand in China, which has become the second-largest consumer of oil in the world after the US. That leads to one of the major reasons why the present recovery is different from previous ones.

We have been accustomed to think of a world economy dominated by the rich developed nations - the members of the OECD. That has been a reasonable proxy for the world economy, for these countries account for some 80 per cent of world GDP. But this recovery is different. My quick "back of an envelope" tally of growth last year suggests that little more than half of the additional growth came from the developed world. China accounted for as much as the US, while India contributed as much as the entire eurozone.

This non-OECD growth has given a different shape to inflation. This early in the growth phase of the cycle, you would not expect much inflation to be coming through. What seems to be happening is that energy and commodity price inflation is arriving unusually quickly. But the downward pressure that China is exerting on manufactured goods is holding down inflation and will presumably continue to do so. As Indian service exports climb, expect downward pressure there too.

Aside from the growth from the not-yet-developed world, the other unusual feature of this recovery is the extent to which it has been driven by cheap money. The US has negative real interest rates, in that the Federal Reserve's 1 per cent money market rate is lower than that for inflation. Parts of the eurozone (Spain and Ireland in particular) have negative interest rates too. Japan has had zero nominal rates for years, so the only reason it has had positive real rates has been its falling price levels.

This experience with very cheap money has been long enough for us to begin to draw some lessons. One is that cheap money will create demand in the English-speaking world but is less effective in continental Europe and Japan.

The present popular wisdom is that the European Central Bank should cut interest rates by 0.5 per cent to boost demand in the eurozone. But the Japanese experience is that this might even have a perverse impact: when Japan cut rates to zero, people saved more and spent less. They felt that they had to save more in order to compensate for the fact that their savings were not building up as a result of interest payments. It is plausible that the Germans would do the same.

Cheap money has almost certainly contributed to the surge in property prices in the English-speaking world but does not seem to have done much for financial asset prices. It may, however, have reduced the self-discipline of the bond markets, arguably creating a bit of a bubble.

This leads to the big question: cheap money has let the world escape from recession, but at what cost?

The most obvious, mentioned by Mr Cotis at the OECD, is imbalances in the fast-moving economies. Growth has been so unbalanced because some parts of the world react swiftly to cheap money while others do not.

There are other costs. Cheap short-term interest rates have pulled down bond yields, encouraging governments to overborrow. If our own Government had to borrow at, say, 8 per cent instead of 5 per cent, it would try much harder to keep its borrowing down. I suspect the same applies to France, Germany and Italy and it certainly applies to Japan. In other words, an easy monetary policy helps permit an easy fiscal policy.

It may also be leading to poor portfolio investment decisions. A flood of money has gone into hedge funds in the US and it is not at all clear that the suppliers of the liquidity know how their money is being used. The hunt for yield is such that almost any investment sounds better than leaving the stuff on deposit earning virtually no interest. The cost will not be evident - until something goes wrong.

The big message here is twofold. We should celebrate this year's good growth, but we should be aware there are costs that will have to be paid for at some stage in the future. As a result of those outstanding bills, it is possible the recovery will not last as long as previous ones and the road ahead may have greater bumps than are now priced into the markets.

Investors can relax about India power shift

Will the unexpected change of regime in India check the economic canter of the world's second-most populous nation? The markets are worried. The Mumbai share index fell 6 per cent to its lowest level since last November, while the rupee fell to a four-and-a-half-month low.

The idea that the communists should be part of the Congress government will obviously send some shivers down the spines of investors in India. They will certainly resist further privatisation - a policy that would have continued had the BJP retained power. There will also be a greater attempt to redistribute some of the wealth generated in the cities to the rural areas.

But markets over-react and there are several reasons why the fall in share prices need not signal the end of India's impressive growth spurt.

For a start, share prices were pretty toppy anyway. When I was in Mumbai earlier this year, the question on everyone's lips was whether there was a share market bubble. A correction was inevitable and political upsets give a rationale for what might well have happened in any case.

More significantly, economic growth is so deeply embedded that it's hard to see the momentum subsiding quickly. The market may actually help a bit in that the fall in the rupee will boost exports, and so further embed demand.

Additionally, there is a substantial reason for suspecting that market-friendly pro-growth policies will be retained by the Congress party: it started them. The reforms of the early 1990s were set in train by the Congress finance minister, Manmohan Singh. He should be acclaimed as one of the great heroes of economic management of the last century, for in five years he transformed the economy and created the conditions for the generation of real wealth for hundreds of millions of people.

He is a frontrunner to become finance minister again. If he does, India's finances will be in sound hands.