Slowing growth in Europe and emerging markets and October’s equity sell off have got economists pondering when the next recession might strike.
Recessions are not rare. Donald Trump, born in 1946, has lived through 12 US recessions. Britain has had eight since the War.
Some countries do better, but they are outliers. The Netherlands had 26 years of interrupted growth 1982 and 2008, a record matched by Australia since 1991. The International Monetary Fund reckons that economies are in a state of recession roughly 10-12% of the time. For most rich world economies recessions are like London buses - there will always be another one along.
The question is not whether there will be a recession, but when will hit and how severe will it be.
Caution and humility is in order here. History shows that economists’ ability to forecast recessions, even big ones, other than when on the verge of one is limited. We tend to forecast gentle movements in the cycle, not major downturns.
Take the Global Financial Crisis. As recessions go this was a massive one, in the case of the UK and many other industrialised economies, the worst since the Great Depression of the 1930s. The crisis started in 2008. In January of that year economists on average forecast that UK growth would come in at 1.8%. The economy actually shrunk by 0.5%. It was not until November 2008, when the UK had already entered recession, that economists came to the view that the economy would contract in 2009. Even then the expectation was that UK GDP would shrink by 0.9%. It was more than four times as severe, with the economy contracting by 4.2%.
The message is that from a distance, recessions almost always look like slowdowns. So what might turn a widely expected deceleration in Western growth next year into something worse?
The US economy is running hot and the US Federal Reserve looks set to raise rates significantly over the next couple of years. This will make life difficult for emerging economies with hefty stocks of dollar debt and vulnerable to big capital outflows. US rates are low by historic standards and the Fed is sitting on more than $4 trillion of assets it bought during the crisis. US monetary tightening has much further to run.
Throw in an escalating cycle of tit-for-tat in terms of trade barriers, especially if countries start to act outside the rules set by the World Trade Organisation, and things could turn nasty.
While the US economy has so far seemed immune to higher interest rates and protectionism, that is unlikely to last. The effect of January’s tax cuts will fade next year. Even the US economy looks to be close to the top of the economic cycle.
Two other longstanding worries have resurfaced in recent weeks. Protectionism and higher US interest rates have revived concerns that the Chinese economy could see a hard landing in 2019 or 2020. Meanwhile the spat between Italy and the EU over the Italy’s plans to increase public spending have highlighted the tensions within Europe’s monetary union.
This isn’t just about the catalyst for a slowdown in growth. It’s also about the policy response. If things were to go wrong it could be harder fighting the downturn this time. The policy cupboard isn’t well stocked.
Interest rates are too low to give much scope for big rate cuts. Government debt is higher than in 2007, which could act as a brake on debt financed public spending. Squabbles within the euro area and between the US and China make international coordination more difficult. Quantitative easing might come to the rescue, but further doses of cheap money and asset price inflation could prove controversial.
The hope is that policymakers and politicians keep a lid on the risks and engineer a smooth and modest slowdown in growth. For 2019 that is the most likely outcome – by some way.
Still, we need to be alive to events which could push us off the gentle slowdown path. The global financial crisis should have dispelled any hubris about our ability to predict growth even over the next year.