March 02, 2016

A Worrisome Recession Scenario

Peter Kennedy

The Economist magazine’s recent feature article on the world economy puts current concerns about the stock market, corporate profits and global economic uncertainty in a broader, and more depressing, context.  While there is scant evidence that a harsh downturn a la 2007-09 is imminent ­– in fact a spate of recent data suggest continuing strength in US construction and auto sales – a new recession scenario is, unfortunately, far from implausible.  And for scenario planners inclined to think in terms of alternative futures, the recession case can be built from a number of developing factors. Here are some of the more salient ones explored in the The Economist piece:

  • It’s going to take more than a reasonably strong US to keep the global economy growing.  In fact, “it may not be enough to keep itself afloat.”
  • Rich countries can’t rely on monetary policy to jump-start growth, with short-term interest rates close to zero.
  • Tax and spending policy levers are constrained by large debt overhangs and (especially in the US) fierce political resistance to public spending hikes and even higher deficits.
  • European banks are very weak, and extremely reluctant to lend to businesses or consumers.  US banks are healthier, in part at least because of more effective incentives and regulations.
  • China is “a source of peculiarly intractable anxiety” and a further slowdown could trigger instability in emerging markets.  A related risk is the unintended consequence of rich-country quantitative easing (or QE – the purchase of government bonds using central bank money), which stimulates capital outflows and debt accretion. These now appear to be destabilizing some emerging markets, and therefore hampering US export potential.

True to form, The Economist piece is not all despair.  That is, the policy tool chest is not quite depleted.  For the rich countries, the most promising route to raising aggregate demand is putting money in peoples’ pockets, through tax cuts (targeted to those most likely to spend them) or hikes in public spending, especially on things like infrastructure projects, which have attractive multiplier effects.  And even with sub-zero interest rates, there are monetary policy tweaks that can still help the cause. 

But let’s not kid ourselves.  It may require a nearly perfect storm of domestic policies and global conditions to avert serious economic problems from developing in the months ahead, especially as US politics grow more bizarrely contentious and damaging to any attempts at globally coordinated fiscal and monetary actions. Political will, in the Eurozone, as well as in the US, is an elusive animal.  And political will is precisely what’s needed to postpone the next recession.