🔒 Is the world heading for recession? Alarm bells are ringing – The Economist

EDINBURGH — The world should start preparing for a recession, says The Economist. The respected business and finance publication outlines the challenges for the global economy after stock markets fell across the world. Although countries are better equipped for recession than last time around, policymakers in richer countries are hamstrung by already-low interest rates. Rising nationalism will make it harder to get a collective effort going to re-energise growth. – Jackie Cameron

By Thulasizwe Sithole

Last week stock markets tumbled across the globe as investors worried, with good reason, for the second time this year, about slowing growth and the effects of tighter American monetary policy, writes The Economist 

“The world economy’s problem in 2018 has been uneven momentum. In America President Donald Trump’s tax cuts have helped lift annualised quarterly growth above 4%. Unemployment is at its lowest since 1969. Yet the IMF thinks growth will slow this year in every other big advanced economy. And emerging markets are in trouble,” it cautions.

“This divergence between America and the rest means divergent monetary policies, too. The Federal Reserve has raised interest rates eight times since December 2015. The European Central Bank (ECB) is still a long way from its first increase. In Japan rates are negative. China, the principal target of Mr Trump’s trade war, relaxed monetary policy this week in response to a weakening economy,” says the global business magazine. 

___STEADY_PAYWALL___

“When interest rates rise in America but nowhere else, the dollar strengthens. That makes it harder for emerging markets to repay their dollar debts. A rising greenback has already helped propel Argentina and Turkey into trouble; this week Pakistan asked the IMF for a bail-out.”

Emerging markets, point out The Economist analysts, account for 59% of the world’s output (measured by purchasing power), up from 43% just two decades ago, when the Asian financial crisis hit. “Their problems could soon wash back onto America’s shores, just as Uncle Sam’s domestic boom starts to peter out. The rest of the world could be in a worse state by then, too, if Italy’s budget difficulties do not abate or China suffers a sharp slowdown.”

The good news is that banking systems are more resilient than a decade ago, when the crisis struck, argues The Economist. “The chance of a downturn as severe as the one that struck then is low. Emerging markets are inflicting losses on investors, but in the main their real economies seem to be holding up. The trade war has yet to cause serious harm, even in China. If America’s boom gives way to a shallow recession as fiscal stimulus diminishes and rates rise, that would not be unusual after a decade of growth.”

But there is bad news, with the rich world in particular ill-prepared to deal with even a mild recession. “That is partly because the policy arsenal is still depleted from fighting the last downturn. In the past half-century, the Fed has typically cut interest rates by five or so percentage points in a downturn. Today it has less than half that room before it reaches zero; the euro zone and Japan have no room at all.”

Read also: Global growth sputters on trade fears – The Wall Street Journal

Central banks could use quantitative easing (QE), the purchase of securities with newly created central-bank reserves, it argues. “If that does not work, they could try more radical, untested approaches, such as giving money directly to individuals. Governments can boost spending, too. Even countries with large debt burdens can benefit from fiscal stimulus during recessions,” reckons The Economist.

“Central banks will enter the next recession with balance-sheets that are already swollen by historical standards — the Fed’s is worth 20% of GDP. Opponents of QE say that it distorts markets and inflates asset bubbles, among other things. No matter that these views are largely misguided; fresh bouts of QE would attract even closer scrutiny than last time. The constraints are particularly tight in the euro zone, where the ECB is limited to buying 33% of any country’s public debt.”

Fiscal stimulus would also attract political opposition, with the euro zone the most worrying case, if only because Germans and other northern Europeans fear that they will be left with unpaid debts if a country defaults, argues The Economist

Read also: Here’s what $100 oil would mean for the global economy

“Its restrictions on borrowing are designed to restrain profligacy, but they also curb the potential for stimulus. America is more willing to spend, but it has recently increased its deficit to over 4% of GDP with the economy already running hot. If it needs to widen the deficit still further to counter a recession, expect a political fight.”

Politics is an even greater obstacle to international action, warns the respected publication. “Unprecedented cross-border co-operation was needed to fend off the crisis in 2008. But the rise of populists will complicate the task of working together. The Fed’s swap lines with other central banks, which let them borrow dollars from America, might be a flashpoint.”

Timely action could avert some of these dangers, says The Economist. “Central banks could have new targets that make it harder to oppose action during and after a crisis. If they established a commitment ahead of time to make up lost ground when inflation undershoots or growth disappoints, expectations of a catch-up boom could provide an automatic stimulus in any downturn.”

Alternatively, adds the economic journal, raising the inflation target today could over time push up interest rates, giving more room for rate cuts. Future fiscal stimulus could be baked in now by increasing the potency of “automatic stabilisers” — spending on unemployment insurance, say, which goes up as economies sag, it says. 

Last week’s market volatility suggests time could be short. The world should start preparing now for the next recession while it still can, adds The Economist.