Odds of Global Recession Low Despite US Slowdown
The global economy probably won’t slide into recession even if the United States does, according to the Economist Intelligence Unit. However, global recession remains a possibility if central bank monetary policy interventions fail to have the desired effect.
“For the next 12 to 18 months, a significant reassessment of risk could lead to huge capital flows into and out of economies, volatile currency swings, big fluctuations in stock and bond prices, and rising alarm among investors,” the EIU says in a free Special Report Heading for the rocks.
This is a recipe for slower growth in much of the world, and brings the risk of a recession that much closer.
The EIU models three scenarios:
• Scenario 1. The EIU’s central forecast, with a probability of 60%, sees the impact of a US housing-driven slowdown being contained by timely monetary policy action, with only a modest effect on the global economy.
• Scenario 2. The EIU’s main risk scenario, with a 30% probability, envisages the US falling into recession, with substantial fallout in the rest of the world.
• Scenario 3. Should the US enter recession, another, darker scenario arises: that corrective action fails, and severe economic repercussions cascade from the US into the world economy with devastating effect. The EIU attach only a 10% probability to this outcome, but the potential impact is so severe that it warrants careful consideration.
Under the EIU’s central forecast (scenario 1), the global economy will grow by 5.1% in 2007 (calculated using purchasing power parity exchange rates) and by 4.8% in 2008. If othe EIU’s main risk scenario (scenario 2) comes to pass, world GDP growth will slow to 4.8% in 2007 and 3.7% in 2008. The growth rate next year would still surpass the 2.4% and 2.9% rates in 2001 and 2002 respectively, and would still be above the threshold that most economists set for a global recession (around 3%).
The EIU believes central banks have learned important lessons from past asset price bubbles, and will not hesitate to pump funds into the economy to cushion a slowdown in growth. In the main risk scenario, the EIU expects the Federal Reserve to look past inflationary pressures (which would evaporate quickly in a slowdown) and cut its benchmark-lending rate from 5.25% to 3.75% by the end of 2008. The European Central Bank will also cut its reference rate, and the Bank of Japan will slow the pace at which it raises rates (from an extremely low level).
“At the same time, our main risk scenario is by no means the worst case. There is a possibility that monetary policy stimulus may have less traction than it did during previous downturns (possibly because of financial innovation itself). There is also a risk that central banks will withhold interest rate cuts for fear of creating a moral hazard that would encourage another round of overinvestment and another asset bubble.”
The EIU Says many policymakers, including the International Monetary Fund, play down the risk of a severe global slowdown, emphasizing the economy’s strong fundamentals This is true only in the narrow sense that global growth has been very strong in recent years. But the global expansion stands on a fragile base, driven by unsustainable consumer demand in the US. The EIU believes that the repricing of risk is a good thing because it will put the global economy on a sounder footing.
The 40-page report includes economic analysis and forecats for each region of the world.
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