FROM THE ECONOMIST INTELLIGENCE UNIT
Recent disappointing data releases in the US relating to jobs, retail sales and housing have revived fears of a double-dip recession. Yet the recent economic news from elsewhere—even the euro zone—has been better than expected, and fiscal and monetary policy in most countries remains supportive of growth. Although another global slowdown looks inevitable, a relapse into recession is unlikely.
In the double-dip scenario, the economic rebound since mid-2009, which was propelled by policy stimulus and stock rebuilding, stalls in the absence of a self-sustaining recovery in final demand. Policymakers are powerless to stop this, having already exhausted all their options to stimulate demand. Excess capacity built up during the credit boom creates deflationary pressures, which makes debt burdens harder to service. The stock of credit shrinks as banks ration loans and households and companies prioritise debt repayment. The global economy falls back into recession.
How likely is this scenario? The Economist Intelligence Unit views it as a serious risk, assigning a 30% probability to it. However, our central forecast is that slower growth is in prospect, not a renewed contraction. A number of factors make a slowdown more likely than a renewed recession.
* Although recent data from the US have disappointed, news from Germany and the euro zone has been better than expected. German manufacturers have full order books and in some cases are struggling to meet demand. The €750bn (around US$975bn) euro zone/IMF financial-stabilisation package has helped to alleviate stresses in euro zone debt markets and funding pressures faced by euro zone banks.
* Emerging markets have mostly come through the crisis in good shape. Even if their exporters face subdued OECD demand, their strong balance-sheets, solvent and liquid banks, favourable demographics, and growing trade and investment links with each other should enable them to keep growing at a decent rate.
* The withdrawal of fiscal policy will in most cases be gradual. In the US the administration is wary of tightening fiscal policy prematurely. It recognises the need for fiscal consolidation to reassure markets about long-term fiscal solvency, but believes it is crucial to maintain support for the economy in the short term. President Barack Obama faces criticism from various quarters about his fiscal management, which will curtail scope for further stimulus. Even so, fiscal policy will remain supportive in the second half of 2010 before becoming contractionary in 2011. Some countries, such as Greece, Spain and the UK, are tightening fiscal policy more aggressively, but given the size of their economies the impact globally will not be too great. Also, the withdrawal of fiscal stimulus may not be as damaging to growth as it might appear at first sight because of the positive impact on household and business confidence about the sustainability of the public finances and future tax burden.
* Although there is now little scope for further cuts in interest rates, central banks are ready to keep policy rates at close to zero for the foreseeable future and to renew unconventional monetary stimulus, if required. Ben Bernanke, the chairman of the US Federal Reserve, said in July that the economic outlook was subject to “unusual uncertainty”. This statement served as a warning of the risks but also demonstrated that central banks are aware of them and are prepared to head them off. In the UK, for example, the Bank of England (BOE) has raised the possibility of reviving its quantitative easing programme, even though inflation—in contrast to the US and the euro zone—is well above the BOE’s inflation target.
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* A final reason for optimism is the rarity of double-dip recessions. There is only one recorded instance of a double-dip in the US, in 1980-81. But while double-dips are rare, we should be wary of taking too much comfort from this. The current cycle is not a typical one in which recession was caused by monetary-policy tightening to choke off inflation. Rather, we are living through a “balance-sheet recession” in which traditional patterns may count for little.
And it is the unusual nature of the current cycle which is the chief source of concern about a double-dip. Excessive levels of debt were built up during the credit boom and these can be worked off only slowly, through a deflationary process of deleveraging, which will depress demand. Record low yields on US Treasuries appear to validate a bleak outlook. In this scenario, the policy stimulus which appeared in 2009 to have rescued the world from a depression only deferred the adjustment. Indeed, some would argue that it made things worse by attempting to deal with a problem of excessive indebtedness by encouraging debtors to borrow more.
The Greek fiscal crisis can be seen in this light. If Greece had not run a budget deficit of almost 14% of GDP in 2009, it might not have lost the confidence of investors. And it is this loss of confidence that is now forcing Greece, and other highly indebted peripheral euro zone countries, to tighten fiscal policy aggressively, increasing the risk of a double-dip recession. Worries about the broader impact of draconian fiscal adjustment are particularly acute in Spain given its high level of private debt and the exposure of Spanish banks to non-performing loans if the economy falls back into recession.
There is no doubt that the recovery is losing momentum and that growth will slow quite sharply in the second half of 2010. In China, the country which did most to avert the threat of a depression, the authorities are deliberately slowing the economy to contain the risk of a property bubble. Growth is likely to slow from almost 11% in the first half of 2010 to around 7% in the second half. We have revised down our forecast US growth in 2010, from 3.3% to 2.7%, while reaffirming our below-consensus forecast of 2% for 2011.
But a slowdown is by no means the same thing as a relapse into recession. Economic recoveries never evolve in a linear fashion and a loss of momentum was inevitable once policy stimulus and inventory rebuilding had peaked. Our central forecast assumes that the world economy is undergoing a transition from an initial recovery phase, led by manufacturing and the inventory cycle, to a consolidation phase, characterised by slower but still positive growth in which the services sector plays a greater role. In this phase governments will pass the baton to companies, which will be able to deploy high levels of cash on their balance sheets to hire staff and invest as they become more confident in the sustainability of the recovery.