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Forecasting a global recession

Sep 9th 2015, 12:54 by Buttonwood

IT IS rare for economists, particularly those at an investment bank, to

forecast a recession. For a start, it is difficult to get it right; a recession

is by definition a change in trend and economists tend to extrapolate from past

ones. But secondly, it is a career risk. One economist once told Buttonwood

that, I never forecast a recession. If I m right, no-one will thank me; if I m

wrong, I ll be fired.

Perhaps it is no surprise that the forthright Willem Buiter, once a member of

the Bank of England s monetary policy committee and now the chief global

economist of Citigroup, a bank, has been willing to go out on a limb. He once

called gold a 6000-year old bubble and back in 2012 predicted that there was

a 90% chance of Greece leaving the euro area. He now says a global recession is

the most likely outcome with a 55% probability. But it is worth noting that

he defines a global recession, not as a period of falling output, but as:

...a period during which the actual unemployment rate is above the natural

unemployment rate or NAIRU [non-accelerating inflation rate of unemployment,

the lowest level of unemployment obtainable without causing inflation due to

the economy overheating], or during which there is a negative output gap; the

level of actual GDP is below the level of potential GDP. To avoid excessive

attention to mini-recessions, this period of excess capacity should have a

duration of a year or longer.

Translating this definition of a moderate recession into GDP growth rates for

the next few years, a moderate global recession starting in the second half of

2016 means global real GDP growth at market exchange rates declining from its

likely current rate of 4% or slightly less, to 2.5% or less by the middle of

2016 and staying at or below 2.5% for a year or more.

So what is driving his view? He cites:

...the very weak indeed negative world trade growth in the first half of 2015,

the continued weakening of (real) commodity prices, the weakness of the global

inflation rate, the recent decline in global stock prices, plus indications

that corporate earnings growth is slowing down in most countries, and the

unprecedented decline in nominal interest rates.

The problem stems from the emerging markets and, in particular, China. No

emerging market is outperforming Citigroup s forecasts for 2015. China s

official numbers may look fine but Mr Buiter reckons the real rate of GDP

growth is currently 4% and may drop to 2.5% by the middle of next year. In

Chinese terms, that is a recession.

Investment in China has been, on average, woefully inefficient especially since

2008. Most of it continues to be allocated to infrastructure, construction and

traditional industrial and extractive activities.

A reduction in the share of fixed investment in GDP by 10% is overdue... the

question is whether this reduction in investment can be achieved without

aggregate demand damage.

He thinks that is unlikely. This will have significant knock-on effects in the

developed world. China s share of world GDP in 2014 was 13.3% and 14.3% of

global trade. Even countries that don t directly trade that much with China

will be affected, since they sell to countries that do export to China. The

developed economies are unlikely to respond with fiscal stimulus. So Mr Buiter

concludes that:

...the monetary authorities once again will have to do the heavy lifting. If

the Federal Reserve and the Bank of England raise rates this year or early next

year they may, if the global recession scenario materialises, be cutting rates

again during the second half of 2016.