Policymakers in rich economies need to consider some radical approaches to tackling the next downturn
AT THE start of most years in the past decade, the list of worries about the world economy has seemed longer than that of reasons for hope. The first few weeks of 2016 have upheld this new tradition. Many emerging markets are wrestling with excessive debts, slow growth, plunging currencies and rising inflation. China, the world’s second-largest economy, is a source of a peculiarly intractable anxiety. If its growth falters, it stokes worries about the prospects for other emerging markets; if activity holds up, though, concerns shift to the ever-rising debt that makes such feats possible, but not necessarily sustainable. The euro area’s troubles are no longer acute; but a chronic condition with an uncertain prognosis is a hard thing from which to take much cheer.
The one big hope has tended to be the American economy. Some indicators there remain robust. The housing market shows few signs of weakness. New jobs are still being added. But despite this, signs of impending recession are now piling up. Economic growth seems to have stalled in the final quarter of 2015. Corporate profits are falling. Stock levels are above normal. Lending standards on bank loans to big firms have tightened, according to the Federal Reserve. A closely watched index from the Institute for Supply Management (ISM) shows that activity in manufacturing fell for the fourth consecutive month in January (see article). The malaise is not confined to factories: the ISM non-manufacturing index is at its lowest for almost two years.
The growing anxiety is mirrored in financial markets. Stockmarket indexes have fallen, dragged down in particular by bank stocks, which have lost 16% of their value (in America) since the start of the year. America’s economy is not strong enough to buoy the world economy up; it may not even be strong enough to keep itself afloat.
Pessimism among investors reflects not just the indicators pointing towards recession. There is a deeper concern that, if or when that recession comes, policymakers will have very few options for dealing with it. Short-term interest rates are close to zero in most of the rich world. The scope for adding further pep through quantitative easing, (QE, the purchase of government bonds using central-bank money) is limited. Long-term interest rates are already low; driving them lower with another round of QE is unlikely to invigorate aggregate demand much more. Tax cuts or increases in public spending could still be effective in fighting recession. But investors worry that there is little scope or appetite for financing a fiscal stimulus with yet more debt. Public debt in America rose from 64% of GDP in 2008 to 104% by 2015; in the euro area, it rose from 66% to 93%; in Japan, from 176% to 237%.
If policymakers appear defenceless in the face of a fresh threat to the world economy, it is in part because they have so little to show for their past efforts. The balance-sheets of the rich world’s main central banks have been pumped up to between 20% and 25% of GDP by the successive bouts of QE with which they have injected money into their economies (see chart 1). The Bank of Japan’s assets are a whopping 77% of GDP. Yet inflation has been persistently below the 2% goal that central banks aim for. In America, Britain and Japan, unemployment has fallen close to pre-crisis levels. But the productivity of those in work has grown at a dismal rate, meaning overall GDP growth has been sluggish. That limits the scope for increases in real wages and in the tax receipts needed to service government debt.
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