The Economist/October 20, 2001 EDITORIAL: The risks are worsening
SUPPOSE that the second-hand car you bought kept breaking down. Would you buy another from the same dealer? The same question might apply to economic forecasters. A year ago, most expected the American economy to grow by 3.5% in 2001. By early this year, they thought that a sharper slowdown, but still a soft landing, was likely; even in early September, almost all still ruled out a recession. Today, however, most believe that a recession was already under way before September 11th. When these same people confidently tell you that this recession will be short and mild-indeed, that it will be one of the mildest in 50 years-why would you believe them? It is surely wishful thinking to hope that the bursting of one of the biggest financial bubbles in history, combined with the aftershocks from the most serious attack ever on America's soil, will be followed by the mildest recession in history. That is not to suggest that America will follow Japan with a decade of stagnation. America is in a healthier state than Japan was at the start of the 1990s. Yet there are good reasons to expect America's recession to be deeper and longer-lasting than most people now expect (see article). One is the sheer scale of investment and borrowing during the late 1990s. Another is the unusually synchronised nature of this global slowdown, with economies around the world sinking together. Indeed, it is possible that the world economy as a whole may be about to suffer its deepest downturn since the 1930s. That, in turn, increases the chances of a deeper recession in America. Despite all this, some commentators fret that policymakers are in danger of easing monetary and fiscal policy by too much, so pushing up future inflation. The Economist has a reputation as an inflation hawk, so one might expect us to be in this camp. On the contrary. If anything, the risk to the global economy is not too much inflation, but too little. As a result of the sharp slowdown in demand, global excess capacity is by some measures at its greatest since the 1930s. That will push inflation lower over the next year, from its already low levels. One result is that growth in the G7 economies will be strikingly low in nominal terms, running at just above 1% in the current quarter. Sluggish nominal GDP growth means that it will take longer to purge the excesses of debt and overcapacity. Unexpectedly low inflation will squeeze profits, exacerbate debt problems and put strains on the financial system. By some measures, in any case, monetary policy is not that loose in America. Using the Fed's favoured measure of inflation, the personal consumption expenditure deflator, real interest rates are still positive. Moreover, rate cuts have failed to ease overall financial conditions much. Such cuts work partly by pushing down the currency or propping up equity prices. Yet, despite the recovery of the past two weeks, share prices are 30% below their peak, and the dollar is stronger than at the start of the year. Heavily indebted firms and households may also be reluctant to borrow more even with lower rates. American interest rates probably need to be cut further. Likewise, starting with the luxury of a budget surplus, America's government is right to be giving the economy a fiscal boost. To be effective, though, any fiscal easing must put money into the hands of those most likely to spend it. The exact shape of the fiscal package now being debated by Congress is therefore more important than its size. Altogether now At least American policymakers are trying hard to stave off a deep recession. The same is not always true elsewhere. Despite worsening deflation, the Bank of Japan beggars belief by arguing that further monetary easing could run the risk of triggering hyperinflation. The European Central Bank also failed to cut interest rates last week. Wim Duisenberg, its president, argued unconvincingly that a cut in rates might dent consumer confidence by giving the impression of panic. And few European governments (except France's, and then only mildly) offer much hope of fiscal stimulus, arguing instead that there should be no relaxation of budgetary discipline. Nor is there much hope from emerging economies, for many in Latin America and Asia are in recession already. Asian governments are at least using their fiscal tools more actively to boost their economies. Singapore's government has announced tax cuts and extra public spending equivalent to 7% of GDP. But many Latin American countries that are heavily dependent on foreign capital, notably Argentina, are actually having to raise interest rates and tighten fiscal policy. Economies such as Japan and Europe, which still have room for monetary or fiscal easing, would be wise to use it. Low inflation and budgetary discipline are fine long-term goals, but they are best put aside when the world economy is flirting with such a deep recession. Copyright © 2001 The Economist Jim Devine [EMAIL PROTECTED] & http://bellarmine.lmu.edu/~jdevine
