Tags: Economy | Stall | Recession

Economy Close to Stall Speed May Signal New Recession

Thursday, 04 August 2011 07:13 PM

Economics isn’t rocket science, but the U.S. economy is a little like a rocket.

If it has enough thrust, it can escape the tug of economic gravity. Not enough, and it just might go into a tailspin. Economists at the Federal Reserve and elsewhere are studying whether today’s slow growth is a precursor to an outright recession -- and if so, why.

It’s widely accepted that a slowly growing economy is more likely to tip into recession, for the obvious reason that it’s already too close to the line; any shock can knock it into negative territory. And today’s slow growth is at least in part a symptom of underlying problems such as consumer indebtedness, high energy prices, and the jitters induced by debt ceiling brinkmanship, Bloomberg Businessweek reports in its August 8-14 edition. _________________________________________________________________________

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What’s harder to prove is the hypothesis that slowness is not just a symptom of trouble but a cause of it. In other words, some economists say, if the economy grows too weakly, that slowness itself could create conditions that lead to a recession.

Why? Maybe the sluggishness undermines consumer and business confidence. Maybe investors lose faith in the recovery so stock prices, already down 9 percent from their April high, plummet. Or maybe lenders get nervous about borrowers’ ability to repay loans and start withdrawing credit. Any such reaction could cause the very downturn that’s feared.

“When the growth rate gets low enough, certain factors may kick in, nonlinearly,” says Menzie Chinn, an economist at the University of Wisconsin at Madison and co-author of a new book, “Lost Decades.”

Debt Deal

The debt deal that President Barack Obama signed on Aug. 2 sets up the economy for what might be called a Christmas crisis: If the congressional super committee that’s supposed to negotiate more cuts doesn’t reach an agreement by Dec. 23, some big spending reductions take effect automatically, sapping demand from an economy that’s already starved for it.

Macroeconomic Advisers, a St. Louis-based forecasting service, said on Aug. 1 that the combination of agreed-upon spending caps and cuts required by the fallback mechanism -- if it’s triggered -- could sap 0.8 percentage points from economic growth in fiscal 2013, which begins in October 2012.

“This economy is really balanced on the edge,” Harvard University economist Martin Feldstein said in a Bloomberg TV interview on Aug. 2.

“There’s now a 50 percent chance that we could slide into a new recession.” Even Federal Reserve Chairman Ben S. Bernanke has referred in speeches to the risk of an economic stall -- another aerospace metaphor. In a stall, a plane loses lift and starts plunging toward the ground.

Useful Warning

Federal Reserve staff economist Jeremy Nalewaik in April published a paper, “Predicting Recessions Using Stall Speeds,” that identified 1 percent growth or less in the economy “as a moderately useful warning sign that the economy is in danger of falling into a recession.” The economy grew at annual rates of just 0.4 percent in the first quarter and 1.3 percent in the second. Nalewaik hasn’t announced what the indicator is saying now about the likelihood of a recession.

The confidence of consumers and businesses will help determine whether slow growth tips over into no growth, says Chris Varvares, senior managing director of Macroeconomic Advisers. “If businesses think things are good, they’ll continue to hire and invest,” he says. “But if they’re very uncertain about the future, the initial slowdown could lead them to put things on hold. If enough firms are doing that, you’ve got a down cycle.”

The problem is that confidence is indeed shaky, increasing the risk that any fresh shock to the system could be enough to push the economy into recession. Business optimism is “softish,” says Varvares: Capital goods orders, excluding defense and aircraft, are growing at an annual rate of 3.5 percent over the past three months before adjusting for inflation, down from 5.6 percent over the past year as a whole.

Foreshadowing Recession

The Institute for Supply Management’s factory index fell to 50.9 in July, just above the 50 mark that divides expansion from contraction. A plunge of this magnitude foreshadowed all six recessions in the past five decades, with only one “head fake,” in 1984, according to economist David A. Rosenberg of Gluskin Sheff & Associates.

Consumers aren’t responding well, either. Retail sales excluding gasoline, building materials, and vehicles grew just 2 percent per year over the past three months, down from a 6 percent rate in the past half-year, Varvares notes. The Bloomberg Consumer Comfort Index is stuck near the lows of the 2007-09 recession. Consumer spending unexpectedly dropped in June for the first time in almost two years.

Unfortunately, lack of confidence in the economy’s prospects could become a self-fulfilling prophecy. This rocket is carrying a heavy payload.

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Economics isn t rocket science, but the U.S. economy is a little like a rocket. If it has enough thrust, it can escape the tug of economic gravity. Not enough, and it just might go into a tailspin. Economists at the Federal Reserve and elsewhere are studying whether today...
Thursday, 04 August 2011 07:13 PM
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