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Politics : Sioux Nation -- Ignore unavailable to you. Want to Upgrade?

To: Wharf Rat who wrote (215273)	8/26/2011 5:36:55 PM
From: Wharf Rat	1 Recommendation Read Replies (1) \| Respond to of 362509

What went wrong with the global recovery? August 18, 2011 8:44 am by Gavyn Davies As recently as six months ago, mainstream economic forecasters were expecting real GDP growth to be comfortably above trend in 2011, and surveys of business activity were hitting new peaks. Of course, everyone knew that the underlying condition of the western economies was still very weak, but that did not seem to be sufficient to prevent a continuing normalisation of economic activity, with GDP returning slowly towards pre-recession trends. We now know that these expectations were extremely complacent. Real GDP growth in the US has slumped to around 1 per cent annualised in the first half of the year, and continental Europe has performed no better in Q2. Forecasters like Goldman Sachs and JP Morgan now estimate that the probability of renewed recession in the US is around one third. So what has gone wrong? It is important to try to understand whether the growth slowdown in the first half of 2011 has been supply or demand determined, and whether the causative factors are likely to prove temporary or permanent. If we can understand these issues, we will be better placed to predict what may happen next. Two adverse factors have been at work on the supply side of the global economy. The natural disasters in Japan in March reduced Japanese GDP growth from what would have been around 2.0 per cent in Q2 to an actual out-turn of -2.4 per cent, directly subtracting 0.5 per cent from GDP growth in the developed world. In addition, the Japanese shock may have indirectly knocked around 1 per cent off annualised GDP growth in other countries as supply chains were disrupted. The good news is that this supply shock is now rapidly correcting itself, and there will be automatic advances in industrial production in Q3 as this happens. The encouraging rise of 0.9 per cent in US industrial production in July may be a pointer in this direction. The second adverse supply shock came from the loss of around 2-3 per cent from global oil supplies as a result of political disruptions in the Middle East. Although this has now been partly replaced by Saudi production, and by the release of International Energy Agency oil stocks, energy prices paid by consumers in the west have been slow to come down. The oil price increases, if permanent, would reduce consumer purchasing power in the developed economies by around 1 per cent this year. But the impact on GDP growth, through a complicated mix of supply and demand side effects, may be greater than this. One model, estimated by James Hamilton at the University of California in San Diego (who is probably the leading academic economist in this field), suggests that the oil shock may have reduced US real GDP growth by 1.1 per cent in the first half of 2011. Unfortunately, according to Prof Hamilton, this negative effect is unlikely to reverse in the second half of the year, even if oil prices subside fairly quickly. In his model, and many others, consumers postpone decisions to buy cars and other energy related durables when oil prices rise, but they do not rapidly revert to their previous habits when prices fall. Now let us turn to factors which relate exclusively to the demand side of the global economy. First, macroeconomic policy has been tightened in recent months, and some of this has been unexpected. In the US, there has been a lot of focus on the fiscal policy of the federal government, which has barely changed this year compared to last, but in fact the main change in the fiscal stance this year has come from expenditure cuts by the state and local government sectors. This has tightened overall fiscal policy by about 1 per cent of GDP in Q1 and Q2. In the UK, fiscal tightening has been running at about 2 per cent per annum, and in peripheral Europe the austerity programme is now much bigger than that. A year ago, we knew that the era of fiscal easing had ended in the developed world, but the extent of the tightening which has occurred in 2011 has come as a surprise. Governments have routinely responded to any form of financial trouble by tightening the near term fiscal stance, while failing to address their long term sustainability problems. This, according to almost all economists who have opined on the subject, is precisely the wrong way around, but that has not stopped them. It now seems most unlikely that this trend will be reversed, short of a second leg of recession. Furthermore, self inflicted policy failings in the US and the eurozone in recent weeks have resulted in financial stress and widening credit spreads. This has tightened monetary conditions much more than the ECB and the Fed intended when they started to press the “exit” buttons in Q2. We do not yet know the full consequences of this tightening, but consumer confidence in the US has plumbed 30 year lows, and business surveys have tumbled everywhere. The final factor, which could turn out to be the most enduring, is the process of debt deleveraging in the western economies. This has left households in a much weaker state to cope with oil and policy shocks than is normally the case. Instead of dipping into savings when faced with temporary shocks, households have rapidly reduced their spending, so a weakening in consumption has been one of the main demand side causes of the global slowdown. Economists like Richard Koo and Ken Rogoff talk of “balance sheet recessions” and a “second great contraction” as if they are entirely unfamiliar developments. They certainly are different from the recessions we have seen outside of Japan in the post-war period, but they could equally be described as a chronic and persistent shortage of demand. Given the prevailing political mood in both Europe and America, that could prove to be a surprisingly difficult problem to solve. blogs.ft.com