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Economics: Recession Threat Lurks Behind Global Policymakers’ Go-slow Focus

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Global economic policy makers may risk making the perfect the enemy of the good. From the Federal Reserve and the German Finance Ministry, to the People’s Bank of China, economic authorities have reacted with restraint to signs of spreading weakness worldwide.

As officials gather in Washington for the annual International Monetary Fund meeting, the danger on minds is that they will misjudge the severity of the slowdown — as they seek to calibrate policy just right — and allow the risk of a recession to morph into reality.

 

Subdued Momentum

IMF projects slowest global growth since financial crisis, then stabilization

“The global outlook remains precarious with a synchronized slowdown and uncertain recovery,” IMF chief economist Gita Gopinath wrote in an Oct. 15 blog post. Citing a broad deceleration as trade tensions undermine the expansion, the IMF this week cut its 2019 global growth forecast to 3%, the weakest performance since 2009 — when output shrank and the financial system tottered.

Policy makers back then pulled out the stops to fight the downturn, slashing interest rates to rock bottom levels and opening up the spending spigots. The stakes now are not nearly that great, especially since the putative U.S.-China trade truce has reduced — at least for now — the biggest risk to the outlook.

As a result, officials are fine-tuning policies to achieve objectives rather than just relentlessly pumping up growth. They’re trying to reduce excessive leverage and engineer soft landings for their economies. So the Fed is trimming rates — it’s expected to move again this month — while governments are holding off from budget-busting fiscal packages.

 

Out of Ammunition

There are other reasons for the restrained response. Some central banks — particularly the Bank of Japan — are virtually out of monetary ammunition. And it takes time for governments to put together and pass changes in taxes and government expenditures.

“Fiscal policy is political and far slower to respond than monetary policy,” Chua Hak Bin, an economist at Maybank Kim Eng in Singapore. It “depends more on the bureaucracy and politics than on the economic cycle.” Another complication: Policy makers don’t have a lot of experience dealing with trade tensions. It’s “something that we haven’t faced before,” Fed Chairman Jerome Powell said in July.

 

China Debt

The more tempered reaction is most evident in China, which is trying to rein in debt that tops 300% of gross domestic product, according to the Institute of International Finance. Rather than launching an all-out borrowing binge as it did a decade ago, the government has responded with more targeted measures, including 2 trillion yuan ($280 billion) of tax cuts and some infrastructure spending. It’s also held off from dramatically loosening monetary policy. “We are not in a rush to roll out massive rate cuts,” People’s Bank of China Governor Yi Gang said Sept. 24.

“Policy makers in China have shown restraint and are allowing growth to slow, partly due to a desire to maintain financial stability,” said Shaun Roache, S&P Global Ratings’ Asia-Pacific chief economist. The downside is that growth next year could slip below 6%, the most tepid pace in decades.

 

Japan’s Economy

The Chinese slowdown has sideswiped Japan’s export-dependent economy. But rather than responding with a looser fiscal stance, Prime Minister Shinzo Abe pressed ahead with an Oct. 1 consumption tax increase that he says is needed to improve the government’s finances but which some economists fear could trigger a downturn. The push to tighten budget policy — even though countermeasures such as tax breaks on buying cars were also rolled out — will pressure the BOJ to expand its already unprecedented stimulus measures.

 

Germany

Germany has also felt fallout from China’s downdraft and looks to be on the brink of a recession. Yet the government has so far resisted rolling out a big budget package.

 

That’s despite pleas from outgoing European Central Bank President Mario Draghi that fiscal policy makers should step up after the central bank resumed quantitative easing last month. Europe’s largest economy is prepared to spend “a lot of money” if it faces an economic crisis, but those conditions don’t exist, Finance Minister Olaf Scholz said Oct. 10.

Under the country’s constitution, the lower house of parliament must first declare a crisis if the government is to issue debt beyond the normal guidelines.The likely result for now is a “slow-motion stimulus,” Berenberg economist Florian Hense told Bloomberg Television on Oct. 10.

 

Federal Reserve

The Fed, for its part, was fairly quick off the mark to cut rates, by a quarter-percentage point each in July and September, even as the economy powered ahead. But it’s unclear how much further it’ll go even though growth now is slowing. Some policy makers have expressed concern that lowering interest rates may encourage risk taking and fuel financial-market bubbles.

Powell has likened today’s situation to two instances in the 1990’s when the Fed cut rates three times, just enough to ensure that the economy “gathered steam and the expansion continued.” But sticking a soft landing and avoiding a crash is not easy. Indeed, research by New York Fed President John Williams suggests the central bank should be aggressive in easing policy when rates are low.

Deutsche Bank Securities economist Matthew Luzzetti said trade policy uncertainty may be tempering the Fed’s response as it tries to sort through sudden shifts in President Donald Trump’s stance and their impact on financial markets. That said, global policy makers have pushed out a fair amount of stimulus, particularly in parts of Asia, the trade shock’s epicenter. But whether that will prove enough remains unclear.

 

– With assistance by Francine Lacqua

Culled from Bloomberg

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