The usual accelerators of recession are absent—but so are the brakes
Aug 27th 2011 | WASHINGTON, DC | from the print edition
HOURS after an earthquake struck America’s east coast on August 23rd, office workers were still milling around the streets of Washington, DC and New York (above), nervously waiting for aftershocks. A similar watch over the economy is now under way. The earthquake that ripped through the American economy from 2007 to 2009 is still generating tremors. The latest may be the strongest yet. Since late July stockmarkets in America and round the world have nosedived, fearful that America is falling back into recession and that Europe’s debt crisis will drag down its banks.
America’s economy is certainly weak. It grew at an annualised rate of just 0.4% in the first quarter and 1.3% in the second. Future revisions may push both numbers into negative territory: the economy would have already double-dipped.
Much of that weakness may be traced to the run-up in oil prices that followed the Libyan uprising and to the Japanese earthquake and tsunami, which disrupted supply chains. As both shocks receded, economic activity turned up. An index of economic reports compiled by the Federal Reserve Bank of Chicago suggests that the economy grew in July (see chart 1), though it may since have flagged again.
Economists have long speculated that weak growth of this sort is like an aircraft’s “stall speed”, below which it risks falling out of the sky. A paper by Jeremy Nalewaik of the Federal Reserve has found that since 1978, whenever the economy has grown less than 1% in a given quarter, a recession has soon followed half to two-thirds of the time. (The results depend on whether growth is measured by GDP or its alternative, gross domestic income).
That is not as helpful as it sounds. Aircraft flying slowly do sometimes crash but, more often, they land. Slow-growing economies that fall into recession are typically pushed, as some shock forces a pre-existing imbalance to tip them over.
Such imbalances are hard to find now in America. Housing, cars and business inventories, the three most volatile components of GDP, usually accelerate the contraction that brings recession. None looks especially stretched. Quite the opposite: house-construction has never climbed off the bottom, and now makes up just 2.4% of GDP, less than half its historical average (see chart 2). Mike Gorman, a builder in northern Virginia, says that his business has collapsed over the past three years. “We went from 40 employees to one part-timer. We’re building just a house or two here or there. It’s been… really, really quiet.” Car production has rebounded, but to a level well below its typical share of GDP. The ratio of business inventories to sales, which soared during the recession, is now back to normal.
The shock that pushes the economy over the edge often originates in financial markets. Although stock prices have plummeted, credit is relatively easy to come by. Spreads on corporate bonds are normal, short-term interest rates are deeply negative when adjusted for inflation, and the Fed’s latest survey has found banks more anxious to lend, “the exact opposite of lending conditions in the run-up to recession,” notes Kevin Logan of HSBC.
Although the absence of obvious imbalances or financial strains does not eliminate the risk of recession in America, it does militate against a long, deep downturn. Indeed, it may be hard for most people to distinguish a shallow recession from lacklustre growth.
A recession indicator compiled by Macroeconomic Advisers, a consultancy, from (among other things) stock prices, the real short-term interest rate, credit spreads, oil prices and the yield curve—the difference between short- and long-term rates—suggests that a recession is unlikely in the next 12 months, even when the yield curve, whose behaviour has been distorted by Federal Reserve policy, is excluded.
But Joel Prakken, the firm’s chairman, has limited confidence in that forecast. The historical data used to predict recessions in the past are less useful if a new shock cannot be offset with fiscal and monetary policy. Japan’s collapse back into recession in 1998 is a cautionary tale. The government raised the consumption tax in April 1997 in an attempt to rein in the rising debt. Two major shocks then aggravated that fiscal restraint: the Asian financial crisis, which pummelled exports, and the collapse of several big financial institutions. With interest rates already at 0.5%, monetary policy could not cushion the blow.
Whether recession is avoided will therefore depend heavily on luck and the wisdom of policymakers. The Fed is not about to tighten monetary policy; indeed, the markets are searching for signs from Ben Bernanke, the chairman, that it may loosen policy through buying more bonds or changing the mix of its bond holdings, though they are likely to be disappointed. However, fiscal policy is likely to tighten as several fiscal measures expire, knocking some 2% off GDP from January onwards. In a speech next month President Barack Obama plans to challenge the special congressional committee now looking for $1.5 trillion in deficit cuts to supply, at the same time, some near-term fiscal stimulus. Republicans are unreceptive. Eric Cantor, their leader in the House of Representatives, recently warned against “discussions of new stimulus spending with money that we simply do not have.”
The brinkmanship that preceded the increase in the debt ceiling on August 2nd, the downgrade to America’s credit rating and the fiscal turbulence in Europe, are the sorts of things that could produce a self-fulfilling collapse in confidence. Steve Alloy, another Virginia builder, recalls how the talk of America defaulting deterred many of his customers. Then, the day after default was averted, five abruptly bought houses. Such stories may serve to concentrate minds in Congress and bring about a more rational fiscal outcome.
Mr Cantor says constituents in his Virginia district have complained that political brinkmanship has pushed the economy to the edge of disaster. Coincidentally, they were also living next to the epicentre of the earthquake. Having lived through terrestrial upheavals, they have no appetite for the economic equivalent.
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