Ryan Avent of ‘The Economist’ considers how the next recession might happen — he asks the following questions:
- When will the next recession be?
- Where will it begin?
- Is the world prepared for a recession?
- What are the obstacles?
- What should governments do?
Very good viewing for macro policies – Unit 4 and 5 of the CIE A2 Economics course.
With the downturn in an economy, cutting interest rates has been the favoured policy of central banks. But the use of quantitative easing (QE) might mean the end of conventional monetary policy with rates already at record low levels – by pushing rates into negative territory they are actually encouraging a deflationary environment, stronger currencies and slower growth. The graph below shows a liquidity trap. Increases or decreases in the supply of money at an interest rate of X do not affect interest rates, as all wealth-holders believe interest rates have reached the floor. All increases in money supply are simply taken up in idle balances. Since interest rates do not alter, the level of expenditure in the economy is not affected. Hence, monetary policy in this situation is ineffective.
Last Sunday there was a very good interview with Canadian economist Armine Yalnizyan on Radio New Zealand’s ‘Sunday’ Programme (with Wallace Chapman). She mentions that the neoliberal policies of the last 30 years have seen income inequality grow and the collapse of consumer spending (C) the main driver of any domestic economy. There has been an increase in the proportion of income accruing to assets which worsens inequality in many countries. China would be an economy that has relied a lot on its export sector (X) for growth but is now trying to drive domestic demand (C) to generate growth. Remember that Aggregate Demand = C+I+G+(X-M). She makes the point that corporates favour the return for shareholders rather than for example
the wages of employees.
“We have this very unusual situation here where corporations are gaining in strength for a host of reasons, similar to the type of corporate power 100 years ago, in key sectors of the economy with less ability to either tax a proportion of the profits they make or regulate their activities.”
Boosting the minimum wage is stimulatory
She also mentions an increase in the minimum wage being stimulatory with lower income groups spending a much higher proportion of their income and thereby increasing consumption. And the vast majority of this spending happens in the domestic economy – C↑. Some have talked of wage inflation by increasing the minimum wage but with the fall in trade union membership and bargaining power this has been significantly reduced. In fact we have seen wage compression.
He-cession and She-covery
However later on in the interview I was interested to her explanation of He-cession and She-covery during the interview.
Recession = “he-cession” – more men tend to become unemployed as areas that are initially impacted by the downturn are manufacturing, mining, construction etc which are likely to be male dominated.
Recovery = “she-covery”: men who lose $30 an hour jobs wince at accepting $15 an hour offers, but women grab them to make sure the bills get paid.
David A. Rosenberg an economist with Clusken Sheff in Canada, has likened the world economy to that of a car being driven by a drunk – that is the car is moving back and across the centre line just missing the ditches on the side of the road. Currently he sees the car in the middle of the road although he questions as to whether this is due to the driver becoming more sober or steering towards the ditch on the other side.
Recently the US stock market (Dow Jones Industrial Average) went above 14000 for the first time in more than five years for the following reasons:
1. Better job figures – employers added 157,000 jobs in January and hired more workers in 2012 than had previously been thought. See chart below.
2. Corporate earnings have been stronger than expected,
3. US Federal Reserve has indicated that it will keep interest rates at near zero levels as well as continuing their policy of monthly $85 billion purchases of bonds and mortgage-backed securities, which injected $3 trillion into the banking system last week.
This third point is particularly important. In the New York Times, Rosenbery stated that he didn’t see the US economy in a recession as yet but could quickly go in that direction. “Anemic growth is my baseline scenario.” Also how long can the US Fed keep propping up equity markets and pumping money into the system? The conditions in Europe are not much better – unemployment rose to record levels in December last year and currently stands at 26.8% in Greece and 26.1% in Spain. Add to that the austerity measures which have impacted greatly on overall aggregate demand and the consumer slowdown in Germany, the eurozone area has its problems. So the car might be in the middle of the road right now but it might not take too much for it to deviate from a safe path.
Below is a graphic showing the levels of unemployment for each month since 1948 and if the economy during that time was in a recession (square in cell). Some points of note:
*In 1953 the level of unemployment was between 2-3% but the US economy was in a recession for the latter part of the year
*The majority of 1960 saw recessionary conditions with unemployment around 6-7%
*1974-75 the economy experienced stagflation – high unemployment and high inflation
*1980-83 periods of high unemployment – the early Reagan years and free market policies.
*1998-2001 – very low levels of unemployment followed by the impact of the 9/11 attacks and the recession that followed
*The financial crisis of 2008 saw 19 consecutive months of recession and unemployment reached between 10-11% in 2009. Since then it has been above 7%.
James Surowiecki of The New Yorker recently looked at the so-called rebound of the US economy. In February this year 200,000 new jobs were created and real incomes were growing also. Other indicators have been positive, for instance new car purchases have increased and the their are signs that aggregate demand is going up. But this demand is not necessarily coming from higher incomes from greater hours worked but the increasing number of young adult Americans living at home – see graph. This means that they have more income to spend on other items rather than rent/mortgage etc. In the article Surowiecki mentions data relating to the number of households.
1947 to 2007 – number of households in the US increased every year,
2008, 2010 and 2011 – number of households dropped even as the population grew.
Economist Scott Sumner came up with the expression Demographic Depression which has been a major cause of the weak recovery. The construction of new homes normally contributes greatly to the level of economic activity but when people are doubling up, there’s little demand for owning or renting. This also impact on peripheral items such as white wear items etc. However when doubling up ceases then we can say that there should be an increase in demand for housing, rentals, and white wear items. Research of past recessions shows that when unemployment falls household formation rebounds quite strongly. But global conditions and commodity prices could lead the Fed to tighten monetary policy but this would be going against what their stand of 0% interest rates to 2014.
Nouriel Roubini – New York University said in 2005 that homeowners have become too used to financing their spending by borrowing against their property. This is all very well until the value of the house declines. Today he says we are going to have further problems in the world economy in 2013/2014 when China faces the situation that the USA experienced in 2008. The world will question how solvent China is and the subsequent chaos will cause a massive global downturn – see news clip below from CNBC.
Richard Wolff (a prominent Marxist economist) – stated that in 2008 that the bursting of the housing bubble would bring about a crisis that would seriously affect American confidence in capitalism and subdue the economy for a long period of time. Shortly after saying this Lehman Brothers went bankrupt.
Here is a clip from the PBS Newshour with reporter Paul Solman and Simon Johnson – former IMF economist and now at MIT. Solman goes back two years when he interviewed Johnson about the shape of things to come in the US business cycle. Looking at today Johnson states:
“So if you think about GDP, here, the story is not so bad. So we were growing up until 2007, end of 2007, early 2008, and we come down pretty sharply, and then we have some recovery. Problem is, we’re not growing fast enough, we haven’t grown fast enough to keep up with population growth. And when you adjust GDP for inflation, we’re about where we were six years ago, end of the second quarter of 2005. So it’s not a lost decade, but it’s a lost half-decade already.”
New York University Professor Nouriel Roubini predicted the 2008 Financial Crisis and is now suggesting that 2013 will be a significant year for the world economy. He makes a number of claims which allude to a major economic catastrophe:
1. There is too much public and private debt worldwide – the US is running over a trillion dollar budget deficit.
2. US unemployment figures are high (9.1%) and the indications are that it will be a this level for a few years
3. The increase in oil and food prices. This leads to less disposable income becoming available for other goods and services
4. Rising interest rates in Asia
5. The Japanese earthquake which has disrupted world trade.
6. Stocks worldwide have lost more than US$3.3 trillion since the start of May
7. China’s economy may face a ‘hard landing’- there are concerns that it will have a lot of excess capacity as world demand dries up.
Here is a clip from Inside Job that has interviews with Nouriel Roubini
A new report shows U.S. employers added 192,000 jobs in February and the jobless rate fell to 8.9 percent. Jeffrey Brown – PBS News Hour – discusses the numbers and recovery prospects with former Labor Department Chief Economist Lisa Lynch and Nariman Behravesh, chief economist at IHS Global Insight, an economic and financial forecasting company. Companies seem to have a more positive attitude to the economy and exports are on the increase. However, with oil well above $100 a barrel there are fears that this could undermine the recovery. Well worth a look.
With the increasing unease in the financial markets around the world and the contraction of many leading economies there has been a resurgence in an unfashionable word -THRIFT. Recent years has seen consumer access to an unprecedented level of liquidity and many who borrowed heavily during this period are now tempted to repay debt and behave in a more prudent manner which, over the last few years, has been seriously out of character. As governments and central banks scramble to try and stimulate spending, by the lowering of interest rates and introducing various tax reforms, does this rise in thriftiness have serious consequences to politicians worldwide? Thrift can become very threatening to a nation. One only needs to turn the clock back on the Japanese economy to realise that a near zero interest rate in the mid 1990s had little effect on a thrifty consumer. Japan subsequently experienced a period of stagnant growth. Many countries today face a similar scenario and the need to keep consumers spending in difficult times is what John Maynard Keynes called ‘the paradox of thrift’. During the 1930s depression Keynes told an audience:
The best guess I can make is that when you save five shillings, you put a man out of work for a day. Therefore, O patriotic housewives, sally out tomorrow early into the streets and go to the wonderful sales which are everywhere advertised. You will do yourselves good … and have the added joy that you are increasing employment, adding to the wealth of the country.
However, with the downturn in an economy, it is a perfectly rational response for consumers to be more prudent in their spending especially with the threat of job losses. Although this might be a rational stance for the individual, it is highly irrational for society as a whole as economic activity is reduced which ultimately leads to business failures and job losses. Therefore by increasing saving, society ends up saving less because there is less income to save from. Economists call this the ‘fallacy of composition’.
What is clear is that this recession will have a psychological effect well beyond the facts and figures of income change and unemployment. It is not about thrift or updating of a thrift ethic rather changing the way you behave. However, are the words of Freddie Mercury and Queen still extremely relevant? “I WANT IT ALL AND I WANT IT NOW.”