The Economy’s So Rosy, Let’s Talk About Recession

LAGOS (Capital Markets in Africa) – We don’t know what will cause it, or when. But it’s coming, and central banks are unprepared.

Although the world economy is in its eighth year of expansion, a casual observer might be forgiven for thinking things have just got going. Don’t worry; they will keep going for a while, according to the International Monetary Fund, which released an update to its World Economic Outlook this week.

Thank the existing growth momentum and, yes, the often-maligned tax cuts signed into law by President Donald Trump last month.

So rosy is the short-term outlook — and so common is that view — that it’s worth wondering what comes next. IMF chief economist Maurice Obstfeld told reporters in Davos, Switzerland, that a recession might be closer than we think. He fretted about the lack of tools to combat the slump when it comes. He was talking mainly about fiscal policy and governments’ strained budgets.

Let me add one more: monetary policy, which perhaps proves again who is really in charge here. If the next downturn happens in a few years, interest rates will not be anywhere close to as high as they historically have been when recessions began. The only way central banks could get them there would be to remove accommodation much faster, which could upset asset prices that are so predicated on low rates. Incidentally, the eradication of easy financing terms is listed first in the “Risks” section of the IMF’s update.

But it’s hard to see accommodation being removed markedly faster in the absence of a big pickup in inflation or, in the case of the U.S., the jobless rate diving quickly toward 3.5 percent. In that case, the Fed may be tempted to take out insurance against a spurt in prices. Still seems rather hypothetical.

By year end, the European Central Bank might well have stopped quantitative easing, but a move in official rates is sometime off in 2019. And in Japan, well, some removal of accommodation is likely at some point, but a rate increase seems quite distant.

Let’s look at the other risks. Like “inward-looking policies,” which is code for nativist vibes aimed at loosening global integration, like ending Nafta or Britain withdrawing from the European Union under unfavorable circumstances. (On the latter, who knows? It increasingly seems like a little parish argument about what the new contours of the long post-1945 national decline look like. The details of Brexit seem more important than they are, just because of the U.K.’s cultural soft power.)

To the broader point, it feels like we have already had at least a year of these kind of tendencies with the U.S., such as withdrawal from the Trans-Pacific Partnership and the Paris climate accord and bellicose comments on Nafta. The world kept chugging along, and globalization didn’t end.

Another that makes the IMF’s list: geopolitical risks. A real evergreen, this one. They keep happening without much sustained broader impact, or at least a cumulative broader impact that can be quantified. On the list from IMF are elections in Brazil, Colombia, Italy and Mexico. (Worth asking if Italy is now an emerging market?)

The list again reflects a Western hemispheric view of the world. I would add general elections in Malaysia and local elections in Indonesia. The latter has a general election scheduled for 2019, as does India.

Even as we can be somewhat dismissive of laundry lists like this, the IMF and Obstfeld are right to warn against complacency. Too many policy makers took too long to realize a global expansion was happening, so it’s entirely plausible that a majority will not notice when the contraction begins.

That’s a useful reminder: There’s always cause to be alert, even though at the moment there’s not exactly cause to be worried.

Source: Bloomberg Business News