American Consequences - February 2019

At this time last year, economic expectations were almost universally optimistic. Every region of the world appeared to be simultaneously booming for the first time since the 2008 financial crisis. Central bankers were confident that they could safely start to withdraw their extraordinary monetary stimulus, and stock market investors were almost unanimously bullish. Yet 2018 turned into the worst year for investors since the financial crisis, forcing central bankers to begin backing away from their plans to normalize monetary policy, economists to downgrade their growth forecasts, and many businesses to prepare for recession in 2019 or 2020. What went wrong? Economic data were only slightly weaker than expected in the second half of 2018. The World Bank, for example, has reduced its estimates of global growth in 2018 and 2019 by just 0.1 percentage points, to 3% and 2.9%, respectively, since its June outlook. The main cause for concern has been the behavior of financial markets. Many economists saw the simultaneous plunge in long-term interest rates and equity prices in December as an indicator of recession: either investors “know something” awful that is not yet evident in the statistics, or declining market sentiment would become a self-fulfilling prophecy by causing businesses or consumers to cut back. But, before concluding that financial markets can always predict or shape the future, we should recall that economic and policy changes usually move financial expectations – not vice versa. So what events, apart from market volatility,

would cause a recession or severe global slowdown? A popular answer is simply the passage of time. The global economic expansion that began in 2009 has already lasted almost 10 years. If a U.S. recession does not occur by 2020, the country will have experienced the longest uninterrupted expansion in its history. Before concluding that ǻRERGMEPQEVOIXWGER always predict or shape the future, we should recall that economic and policy changes usually move ǻRERGMEPI\TIGXEXMSRWƳ not vice versa. There is nothing in economic theory or historical experience to suggest that expansions die of old age, or that recessions happen spontaneously. But expansions do become more vulnerable to diseases of old age: high interest rates, rising energy prices, accelerating inflation, or banking crises that are triggered when unsustainably high property prices suddenly collapse. And if none of these economic mishaps occurs, eventually political leaders can become recklessly overconfident, leading to wars, trade conflicts, or gross budgetary mismanagement. Several of these problems began to appear in 2018: rising interest rates in the U.S., fiscal tightening in Italy and much of Europe, an escalating tariff war between the U.S. and China, and higher energy prices around the world. It is not surprising, therefore, that the


February 2019

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