Global Slowdown, European Recession, Will Qualify US Growth Prospects
Even as measures of business and consumer optimism have improved in the United States, the global economy has struggled to extricate itself from a state of crisis. Fueling current headwinds, Europe’s ongoing condition of political paralysis has meant a lack of progress in addressing the Continent’s ripening sovereign debt crisis. Where progress has been made in adopting austerity plans and deleveraging bank balance sheets, these necessary steps have impinged on near-term growth. The U.S. economy is not impervious to negative developments among our major trading partners, nor is credit availability unaffected by disruptions to the global financial system. In spite of improving economic data, potential spillovers from diverging global growth trends remain ensconced as qualifiers of the domestic outlook.
Further evidence of the euro zone’s problems was meted out last week, when the United Kingdom’s Office of National Statistics released its preliminary growth estimate for the fourth quarter. According to the early measure, the U.K. economy contracted by 0.2 percent in the final months of 2011, succumbing to a less favorable investment environment and a drop in production activity. In the three months ending in November, the U.K.’s unemployment rate inched up by 30 basis points, to 8.4 percent, while the pace of wage growth slowed. Stoked by the January 2011 increase in the value-added tax, inflation moderated in December but was still unacceptably high at 4.2 percent. The coincidence of observable inflationary pressures and a faltering economy has constrained British policymakers. Even if they have made public efforts to anchor inflation expectations, conventional monetary policy is a blunt instrument when the long-term yield on gilts is already negative. In the alternative scenario mulled by the Bank of England’s Monetary Policy Committee, price pressures abate too much and below-target inflation presents a challenge in its own right.
Semantic debate now rages in Britain as to whether the country has slipped into a double-dip recession. The outlook for the euro zone itself is hampered by similar questions. In its January update to its World Economic Outlook, released last Tuesday, the International Monetary Fund downgraded its projections for global growth. From a September 2011 forecast of 4.0 percent growth in 2012 and 4.5 percent growth in 2013, the IMF now believes that the global economy will expand by 3.3 percent this year and by 3.9 percent next year. The euro zone will be the principle drag on activity, falling back into recession and contracting by 0.5 percent during 2012.
Adjustments to the IMF outlook were not limited to the euro zone, but included sharp revisions to growth in many of the emerging and developing economies that depend upon export demand or that have wavered on monetary policy, including India and China. The report’s overarching theme is summed up in the IMF’s sobering assessment: “The global recovery is threatened by intensifying strains in the euro area and fragilities elsewhere. Financial conditions have deteriorated, growth prospects have dimmed, and downside risks have escalated.”
Developments on the global stage may seem rather removed from recent trends in the United States. Falling initial claims for unemployment insurance, a new record in after-tax corporate profits, and small but sustained improvements in consumer and business confidence suggest that the U.S. economy has finally found its footing. Such a view might be reinforced by the headline results of last Friday’s GDP report. According to the Commerce Department’s advance estimate of fourth-quarter growth, the domestic economy seemed resilient to spillovers from Europe. Even as the U.K. economy contracted, GDP in the U.S. expanded by 2.8 percent, the best result in 18 months.
While growth in 2012 is projected to outpace the meager 1.7 percent expansion estimated for 2011, the fourth quarter’s headline momentum will be difficult to sustain. Friday’s result depended inordinately on inventory buildups by private firms rather than upside surprises in personal consumption and private investment in capital and equipment. Even if demand for final goods and services picks up strongly—an unlikely scenario given weak wage growth and already reduced savings rates—the level of inventory investment observed in late 2011 must revert to a more measured pace over the coming quarters.
Combined with headwinds from cutbacks in federal, state and local government expenditures, the net effect is a GDP outlook that improves on 2011 while falling short of the economy’s potential growth rate.
As of last week’s meeting of the Federal Open Markets Committee, the Fed’s central tendency projections anticipate growth between 2.2 percent and 2.7 percent over the coming year. That is an improvement over 2011 and one that largely anticipates a resolution to the European crisis. The latter is a strong assumption. At last Wednesday’s postmeeting press conference, Fed Chairman Ben Bernanke invoked global developments as a qualifier to the 2012 projections: “Strains in global financial markets continue to pose significant downside risk to that outlook.”
Dr. Bernanke’s measured tone should not be taken as a lack of concern. Avoiding tail risks that could foment a damaging renewal of illiquidity is essential, not only for the economy as a whole but also for the continued recovery of commercial real estate investment and credit markets. The notion that European challenges are supporting the real estate recovery by keeping our risk-free interest rates low is dangerously shortsighted where it fails to recognize the attendant risks of contagion should conditions worsen.
Sam Chandan, PhD, is president and chief economist of Chandan Economics and an adjunct professor at the Wharton School.