According to Goldman Sachs, the momentum of global economic growth slowed markedly in 2018. The most globally significant slowdown has been in the Chinese economy – the main engine of global growth since the financial crisis of 2007-08. But, Germany and Japan also recorded economic contractions in the third quarter of last year, i.e. 2018. Stock markets have also been in turmoil. In part, that presumably reflects worsening perceptions of prospects.
All this suggests a cyclical slowdown is on the way. Yet conventional forecasters are hardly unduly worried. The OECD stated last November that the “global expansion has peaked” and that global gross domestic product (GDP) growth is “projected to ease gradually from 3.7 percent in 2018 to around 3.5 percent in 2019 and 2020, broadly in line with underlying global potential output growth”. This would be an ultra-soft landing.
A mild economic slowdown should hardly be problematic. On the contrary, it is to be expected. In the high-income economies, which still generate three-fifths of world output (at market prices), the cyclical upswing is elderly and excess capacity has fallen sharply. Where the expansion is most advanced and excess capacity has disappeared, monetary policy has been duly tightened, quite appropriately. Happily, inflation is still subdued and nominal and real interest rates are low. While equity markets have indeed corrected, US stocks have rarely been as highly valued as today.
Nothing here suggests a severe global recession is on the way. Indeed, it bears remembering that while capitalist economies have always been cyclical, severe recessions, especially global ones, are rare. It would appear wise, in sum, for everybody “to keep calm and carry on”.
Yet there is a catch — a big one. The short-term cycle is the least of our challenges. There are also structural changes in the form of differential productivity trends and the long-term debt cycle. Crucially, these developments have made the world economy fragile.
Read More: Where is the World Economy Heading?
“Productivity” should be viewed as a shorthand way of summarising the shifts in global economic power, widening inequality, collapse in employment in manufacturing, rise of the digital economy and the “savings gluts” of past decades. The long-term debt cycle, which accelerated from the 1980s, was, among other things, a way to manage the social and economic consequences of those structural shifts. These structural shifts have had big political effects: a surge in nationalism and populism, Brexit, the election of Mr Trump, a trade war between the world’s two most important economies and an erosion of the liberal global economic order. The long-term credit cycle reached its denouement in the disastrous financial crisis of 2007-08. Today, China, whose long-term debt cycle accelerated after the crisis, is reaching the limits of debt accumulations, too.
These long-term conditions significantly constrain any optimism one feels over a short-term cyclical slowdown.
A powerful implication is that room for a response to a recession would be limited by historical standards, especially in monetary policy. If the US Federal Reserve had to make a standard response to a significant recession, its short-term rates might need to be minus 2.5 percent. The European Central Bank and Bank of Japan would have to go further still. If the worst came to the worst, the Fed and the ECB might be forced to follow the BoJ into even more deeply unconventional policies. While the People’s Bank of China has more room for manoeuvre, reigniting China’s credit boom carries longer-term risks.