ND CRISIS
Beyond the U.S., the fragility of growth in debt-ridden China and some other emerging markets remains a concern, as do economic, policy, financial, and political risks in Europe. Worse, across the advanced economies, the policy toolbox for responding to a crisis remains limited. The monetary and fiscal interventions and private-sector backstops used after the 2008 financial crisis simply cannot be deployed to the same effect today. The 10th factor that we considered was the U.S. Federal Reserve’s interest-rate policy. After hiking rates in response to the Trump administration’s pro-cyclical fiscal stimulus, the Fed reversed course in January. Looking ahead, the Fed and other major central banks are more likely to cut rates to manage various shocks to the global economy. While trade wars and potential oil spikes constitute a supply-side risk, they also threaten aggregate demand and thus consumption growth, because tariffs and higher fuel prices reduce disposable income. With so much uncertainty, companies will likely opt to reduce capital spending and investment. Under these conditions, a severe enough shock could usher in a global recession, even if central banks respond rapidly. After all, in 2007-2009, the Fed and other central banks reacted aggressively to the shocks that triggered the global financial crisis, but they did not avert the “Great Recession.” Today, the Fed is starting with a benchmark policy rate of 2.25%-2.5%, compared with 5.25% in September 2007. In Europe and Japan, central banks are already in negative-rate territory and will face limits on how much further below
Last summer, my colleague Brunello Rosa and I identified 10 potential downside risks that could trigger a U.S. and global recession in 2020. Nine of them are still in play today. Many involve the United States. Trade wars with China and other countries, along with restrictions on migration, foreign direct investment, and technology transfers, could have profound implications for global supply chains, raising the threat of stagflation (slowing growth alongside rising inflation). And the risk of a U.S. growth slowdown has become more acute now that the stimulus from the 2017 tax legislation has run its course. Meanwhile, U.S. equity markets have remained frothy since our initial commentary. And there are added risks associated with the rise of newer forms of debt, including in many emerging markets, where much borrowing is denominated in foreign currencies. With central banks’ ability to serve as lenders of last resort increasingly constrained, illiquid financial markets are vulnerable to “flash crashes” and other disruptions. One such disruption could come from U.S. President Donald Trump, who may be tempted to create a foreign-policy crisis (“wag the dog”) with a country like Iran. That might bolster his domestic poll numbers, but it could also trigger an oil shock.
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July 2019
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