Listener20 October, 2001
Keywords: Macroeconomics & Money
There were two views on the world economy on September 10th. The optimistic conventional wisdom thought the world economy was about to enter a recession, and would be out of it by the end of this year. A smaller group, although in my view better informed and with a better recent track record of forecasting, thought the world economy was already in recession (although this is partly a matter of definition) and expected the slowdown to continue well into next year.
While the pessimists do not seem to have changed their views much, following the terrorism of September 11th, the optimists have started talking about the world recession going into 2002. It is not obvious that the day’s events resulted in any fundamental changes to the world economy, for the property damage is less than a good American hurricane (and the people damage less that what happens when Bangladesh cops one). Blaming the downturn on terrorism is exactly what the extremists want to hear, but there is little scientific justification for it. The optimists have used the terrorism to allow them to adjust their views, since the recession in its early stages has been more serious than they hoped.
It remains unclear just how long the world recession will last, and how deep it will be. We know that many firms and households have unsatisfactory balance sheets, with high liabilities relative to their assets if they are valued realistically. But we do not know whether the sheets will become exposed to the down turn (as happened in New Zealand and Australia after 1987) or whether they will work their way out of the imbalance (as appears to have been happening in the US over the last two years). There remains the dreaded possibility that the US economy could join the stagnating Japanese one which has struggled for a decade with rort balance sheets. The best bet is that this will be the worst post-war recession, but that it will be mild compared to some of the great depressions before the 1940. Yet a Japanese type long stagnation remains a significant downside risk.
Intriguingly, confidence in recent policies is beginning to crack, with some commentators pointing out that monetary policy will not stimulate an upswing. One recalls the Keynesian wisdom that monetary policy can be as effective as pushing on the string of a descending balloon. That has been the Japanese experience. There are increasing calls for fiscal stimulus – running a large government deficit, and even subsidising key industries. The conventional wisdom may be offering very different nostrums this decade compared to the ones it offered in the last.
Under the optimistic scenario of a relatively short world recession, New Zealand’s export sector was expected to falter as its prices and sales fell, but the optimists thought that the domestic sector of consumption and housing construction would lift, bridging the external sluggishness until the early (so they thought) international recovery. However a longer world recession would hit New Zealand with rising unemployment, and stagnation or worse. The good news is that the New Zealand government goes into the world recession with the strongest fiscal position, I can recall. The public debt is not high by international or past standards, and neither is the ongoing borrowing (which funds new investment and rolls over debt). The Minister of Finance was right to say that government will switch over to deficit financing if things get too rough. The public balance sheet allows that to be a prudent action. Of course every lobby group will demand extra spending or tax cuts in their self interest (and election year will add to the clamour). However, assuming the world does not collapse into a depression, counter-cyclical spending is required. Such spending has to be reversible (so it can be turned off when the economy recovers) and to have as low import content as possible (to get the maximum employment effect). The range of prudent measures is smaller than the outcry will suggest.
I am less confident about the balance sheets of New Zealand businesses. Did they learn from 1987 crash? The most dangerous phrase during a business downturn is ‘this time it is different.’
While it suits the optimists to blame the terrorist attack for a more serious recession than they had been previously forecasting, the irony is that it may actually shorten it. The hysteria of the anti-terrorist campaign may enable the US to run a more stimulating fiscal position, since ideological conservatives find it hard to speak against spending on warfare. The US Congress has already voted the equivalent of a year of New Zealand’s GDP to combat terrorism, but the ‘war’ may well end up like the Vietnam morass which led to the long upturn in the 1960s (and inflation). Even so, fiscal stimulation has not ended the Japanese stagnation, because they have never really addressed their rort balance sheets.