Data from the US — rising unemployment, falling household consumption, still declining industrial production, and a weak housing market — suggest that America’s recession is not over yet. A similar analysis of many other advanced economies suggests that, as in the US, the bottom is quite close but it has not yet been reached. Most emerging economies may be returning to growth, but they are performing well below their potential.
Moreover, for a number of reasons, growth in the advanced economies is likely to remain anaemic and well below trend for at least a couple of years.
The first reason is likely to create a long-term drag on growth: households need to deleverage and save more, which will constrain consumption for years.
Second, the financial system — both banks and non-bank institutions — is severely damaged. Lack of robust credit growth will hamper private consumption and investment spending.
Third, the corporate sector faces a glut of capacity, and a weak recovery of profitability is likely if growth is anaemic and deflationary pressures still persist. As a result, businesses are not likely to increase capital spending.
Fourth, the re-leveraging of the public sector through large fiscal deficits and debt accumulation risks crowding out a recovery in private-sector spending. The effects of the policy stimulus, moreover, will fizzle out by early next year, requiring greater private demand to support continued growth.
Domestic private demand, especially consumption, is now weak or falling in over-spending countries (the US, the United Kingdom, Spain, Ireland, Australia, New Zealand, etc), while not increasing fast enough in over-saving countries (China, Asia, Germany, Japan, etc) to compensate for the reduction in these countries’ net exports. Thus, there is a global slackening of aggregate demand relative to the glut of supply capacity, which will impede a robust global economic recovery.
There are also now two reasons to fear a double-dip recession. First, the exit strategy from monetary and fiscal easing could be botched, because policymakers are damned if they do and damned if they don’t. If they take their fiscal deficits (and a potential monetisation of these deficits) seriously and raise taxes, reduce spending, and mop up excess liquidity, they could undermine the already weak recovery.
But if they maintain large budget deficits and continue to monetise them, at some point — after the current deflationary forces become more subdued — bond markets will revolt. At this point, inflationary expectations will increase, long-term government bond yields will rise, and the recovery will be crowded out.
A second reason to fear a double-dip recession concerns the fact that oil, energy and food prices may be rising faster than economic fundamentals warrant, and could be driven higher by the wall of liquidity chasing assets, as well as by speculative demand. Last year, oil at $145 a barrel was a tipping point for the global economy, as it created a major income shock for the US, Europe, Japan, China, India and other oil-importing economies. The global economy, barely rising from its knees, could not withstand the contractionary shock if similar speculative forces were to drive oil rapidly towards $100 a barrel.