The world economy is like an ocean liner without lifeboats If another recession hits… …it could be a truly titanic struggle for policymakers
Remarkably enough, it has been six years since the trough of the last US recession. If history is any guide, we are probably now closer to the next one. Yet whereas previous recoveries have enabled monetary and fiscal policymakers to replenish their ammunition, this recovery – both in the US and elsewhere – has been distinguished by a persistent munitions shortage. This is a major problem. In all recessions since the 1970s, the US Fed funds rate has fallen by a minimum of 5 percentage points. That kind of traditional stimulus is now completely ruled out. Meanwhile, budget deficits are still uncomfortably large and debt levels uncomfortably high: while the US fiscal position has improved, it remains structurally weak. We investigate the options for policymakers given this shortage of traditional ammunition, including: (i) reducing the risk of recession; (ii) reverting to quantitative easing; (iii) moving away from inflation targeting; (iv) using fiscal policy to replace monetary policy; (v) using fiscal and monetary policy together in a bid to introduce so-called “helicopter money”; and (vi) pushing interest rates higher through structural reforms designed to lower excess savings, most obviously via increases in retirement age. We conclude that only the final option is likely to lead to economic success. Politically, however, it seems implausible. As a result, we are faced with a serious shortage of effective policy lifeboats. As for plausible recession triggers, we highlight four major risks: a rise in US wages which leads to a falling profit share and a major equity decline; a series of systemic failures within the non-bank financial sector; a major weakening of the Chinese economy, sending shockwaves around the world; and a premature attempt by the Federal Reserve to normalise monetary policy, in a repeat of the mistakes made by the Bank of Japan in 2000 and, more recently, by the European Central Bank in 2011.
Economics Global
The world economy’s titanic problem
Coping with the next recession without policy lifeboats
13 May 2015
Stephen King
Chief Economist HSBC Bank plc +44 20 7991 6700 stephen.king@hsbcib.com View HSBC Global Research at: http://www.research.hsbc.com Issuer of report: HSBC Bank plc
Disclaimer & Disclosures
This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it
2 Economics Global 13 May 2015
abc
Not quite a return to normality
In most economic cycles, the recovery phase has not just marked a return to economic growth. It has also, eventually, marked a return to policy “normality”. Interest rates have risen. Tax revenues have rebounded. Welfare payments have shrunk. Budget deficits have declined – and, on some occasions, have even turned into surpluses. Put another way, a return to economic growth typically allows policymakers to rebuild their stocks of ammunition, providing them with room to fight the next economic battle. This latest economic cycle is, to date, fundamentally different. According to the National Bureau of Economic Research, the last trough in US economic activity was reached in June 2009. Almost six years into recovery, official short-term interest rates haven’t budged an inch. 10 year Treasury yields are at rock bottom, still lower than they were in the immediate aftermath of the collapse of Lehman Brothers in 2008. The Federal budget deficit has dramatically improved but the fiscal position is nothing like as healthy as it typically has been through previous economic cycles (charts 1-3).
1. Still waiting for the Fed
Source: Thomson Reuters Datastream, National Bureau of Economic Research
04812162004812162071 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15% %Federal funds target rate (horizontal lines show ECRI business cycle troughs)
The world economy’s titanic problem
Remarkably enough, it’s six years since the last recession…
…suggesting the next one may not be too far away…
…yet there is a total absence of traditional policy ammunition
3 Economics Global 13 May 2015
abc
2. Yields are close to rock bottom 3. The Federal deficit has improved but, by past standards, is still large
Source: Thomson Reuters Datastream Source: US Treasury, National Bureau of Economic Research
Other regions offer a similar narrative. True, the European Central Bank tried to raise interest rates in 2011, but its attempts ended in ignominious failure: having reversed its rate increases, the ECB is today committed to quantitative easing that, on current plans, is likely to extend all the way through to September 2016. The Bank of Japan is in a similar position. The Bank of England is no longer increasing its balance sheet via quantitative easing but, despite having had the urge, it has so far been unable to find an opportunity to raise interest rates. Fiscal positions, meanwhile, are mostly poor – at least when compared with those pre-crisis.
4. The ECB raised rates and ended up with egg on its face 5. Quantitative easing no longer looks unconventional
Source: Thomson Reuters Datastream Source: Thomson Reuters Datastream, Bloomberg
Three reasons why policy hasn’t “normalised”
One reason for this lack of action – this failure to rebuild stocks of ammunition – is simply that the pace of economic recovery has not been particularly strong. Chart 6 shows the average annual US growth rates during equivalent six-year periods following economic troughs over the last forty years. The latest recovery is particularly weak. Then again, so was the previous recovery. Back then, however, the Federal Reserve was able to raise interest rates 31 months after the trough in economic activity. This time, 70 months have elapsed (at the time of writing) and still the Fed hasn’t acted.
012345670123456700 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15Yield Yield10 Year Treasury YieldsLehman Brothers collapse-12-10-8-6-4-2024-12-10-8-6-4-202454 58 62 66 70 74 78 82 86 90 94 98 02 06 10 14%GDP %GDPFederal budget balance - vertical lines show NBER business cycle peaks)
-1012345-101234500 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15ECB repo rate ECB deposit rate% %
0100200300400500600010020030040050060007 08 09 10 11 12 13 14 15BoE ECB Fed BoJCentral bank balance sheets, Jan '07 =100Index Index
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