Thursday, 18 July 2019 12:39 GMT

Expansions Don't Die of Old Age

(MENAFN - Daily Outlook Afghanistan) The US economy hasentered its 11th year of uninterrupted expansion, breaking the previous recordfor the longest period of growth in American history without a recession. Butfar from celebrating, many economists conclude from this unprecedentedperformance that a recession is now overdue, if not immediately then surelybefore the 2020 presidential election. Fortunately for the US economy, butsadly for President Donald Trump's opponents, the idea that economic expansionshave some kind of natural lifespan and then die of old age has neitherempirical nor theoretical support.
History shows that USexpansions since the end of World War II have varied in length from 12 monthsto 120 months, with no sign of mean reversion. Moreover, it can be argued thatthe 18-year period from 1982 to 2000 was really one continuous economicupswing, interrupted only briefly by the spike in oil prices caused by Iraq'sinvasion of Kuwait.
And there are clearerinstances of advanced economies that have avoided recessions for much longerthan the ten-year record the United States has just surpassed. Australia is nowin its 28th year without a recession, and the United Kingdom experienced 17years of uninterrupted growth from 1992 to 2008. Unlike the US, both Australiaand the UK are more recession-prone because of their dependence on commodities,finance, and property speculation.
Economic principlesare equally unhelpful to advocates of the 'overdue recession theory. Thenormal condition of any reasonably well-managed market economy since theinvention of active demand-management policies in the 1940s is to continueexpanding at around its trend rate of growth (roughly 2% in the US). In thepostwar period, recessions have generally resulted from three causes:substantial monetary or fiscal tightening in response to inflationarypressures; some kind of financial crisis, such as the subprime mortgagecollapse of 2008 and the technology bust of 2000; or a massive external shockthat vastly increased energy prices. Until one of these events occurs, we canbe fairly confident that the US expansion will not just 'die of old age.
Why, then, are somany economists now worried about a US recession and convinced that financialmarkets are underestimating the downside risks to economic growth? The mainreasons are the US-China trade war and a financial warning signal: the'inverted yield curve. The first risk is obvious; the second requires someexplanation.
An inverted yieldcurve is a relatively unusual condition that occurs when long-term bond yieldsfall below short-term interest rates. In the US, the overnight federal fundsrate is around 2.4%, but ten-year yields recently fell to below 2%.
Such an inversion isoften cited as a signal of imminent recession, but it shouldn't be. The'signal often comes years before the recession it claims to predict. Moreimportant, bond market pricing has drastically changed in the decade since theglobal financial crisis. Bond yields have become increasingly divorced fromreal economic conditions, partly because of quantitative easing and regulatorypressures on pension funds to buy bonds regardless of economic conditions, butmainly because inflation seems to have decoupled from unemployment and growth.
Even if thedecoupling of growth and inflation ultimately turns out to be illusory, themere fact that the US Federal Reserve and other central banks believe that theold growth-inflation linkage is broken means that they will keep interest ratesmuch lower for much longer than in previous economic cycles. As long as centralbankers continue to behave like this, bond yields will continue to reflectinvestors' expectations about what central banks will do with short-terminterest rates, rather than their expectations about economic prospects orrecession risks. The main message from financial markets, as I argued in April,is not that the US is near a recession; it is simply that the Fed is preparingto cut interest rates. If that happens – and it almost certainly will – a USrecession will become less likely, not more so.
The same is true inChina. The Chinese government and central bank have responded to Trump's tradewar, albeit somewhat belatedly, by cutting interest rates and reserverequirements, reducing taxes, ramping up public spending, and easing creditrestraints. China's stimulus measures, like the Fed's expected easing, willtake some time to feed through into economic data, but these measures virtuallyguarantee that the US-China trade war will cause only limited damage to growthprospects in both countries, at least in the next year or two, which is thetime horizon over which macroeconomic policies operate.
A much more seriousthreat to the world economy comes from Europe, an innocent bystander in theUS-China trade war that has already suffered far more than either of thebelligerents. When the International Monetary Fund revised its 2019 growthprojections in April to take account of the problems that emerged in late 2018,the forecasts for China and the US were essentially unchanged, despite theirtrade war (up 0.1 percentage point in China, down 0.2 in the US). But the IMFdowngraded its growth forecast for Germany by 1.1 percentage points, by 0.9 forItaly, and by 0.6 for the eurozone as a whole.
Europe has been themain victim of the US-China trade war, for the same reason it was the mainvictim of the 2008 financial crisis, which also originated in the US. While theUS and China are stimulating their economies to counteract the trade slowdown,the European authorities are, as usual, responding with exactly the wrongpolicies. Instead of easing monetary, fiscal, or credit policies, the eurozoneresponse is 'pro-cyclical. The European Commission is trying to force Italy toreduce public spending and raise taxes. Germany's finance ministry is usinglower-than-expected budget surpluses as an excuse to squeeze investment anddelay tax cuts. And bank supervisors are forcing banks to tighten their creditstandards, increase loss provisions, and cut lending to preserve capital.
Such policiescondemned Europe to spend most of the post-crisis period in recession ornear-recession, while the US and China enjoyed a decade of uninterruptedgrowth. If similarly foolish policies are maintained, the same thing willhappen again.


Expansions Don't Die of Old Age

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