Excess austerity is a bigger risk than fiscal profligacy.
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When people are fundamentally healthy, they do not yet know what will cause their death.
An economic recovery is healthy if it is not clear what will cause the next recession.
By this standard, the recovery from the 2008 financial crisis, although disappointingly slow, has been healthy for most of the last decade. This is now in serious doubt. Paul Samuelson’s quip that the stock market has predicted nine of the last five recessions cautions against overreacting to recent stock market moves.
But credit spreads have widened considerably, commodity prices have softened and investors have started demanding higher yields for short-term US bonds than for those with longer terms. Unlike equity markets, “yield curve inversions” have not historically tended to produce false recession predictions. The overall judgment of financial markets is that recession is significantly more likely than not in the next two years.
Real economic indicators for the world’s largest economies, China and the US, also suggest considerable cause for concern.
Almost every Chinese indicator in the last few months has come in below expectations. Beijing authorities now see the need for stimulus measures if they are to credibly report the attainment of growth targets.
Revisions of economic forecasts tend to run in the same direction for protracted periods as forecasters adjust to emerging reality.
This tendency is especially pronounced in China, given the extreme political sensitivity of economic statistics.
In the US, inflation is again running below the Federal Reserve’s 2 per cent target and comparisons of the yields on ordinary and inflation-adjusted bonds suggest investors expect this to continue for the next decade.
While jobs growth remains strong, employment is usually a lagging statistic. Forward-looking indicators of business and consumer sentiment suggest that growth is likely to slow.
Perhaps the US economy will enjoy a soft landing: jobs growth would slow towards long-run sustainable levels, and productivity growth would accelerate enough to allow continued gross domestic product growth of 2 per cent and increased wage growth without accelerating inflation.
But this would require both policy skill and great luck. Given that we are starting from very high debt levels and low unemployment, a recession is the more likely outcome.