Tuesday, October 04, 2011

A self-induced recession

An item at the Economist that is making the rounds conveys a quite frustrating aspect of the economic situation in Europe and the U.S.: "A self-induced recession"
YOU know, if it weren't for the politicians, the economy would have a fighting chance.
But last week the Economic Cycle Research Institute (ECRI), a boutique firm that specialises in business-cycle turning points said America is “tipping into a new recession. And there’s nothing that policy makers can do to head it off.” ECRI is not well known to the general public but at times like this I pay them special attention because their indicators are designed to capture turning points and their track record is pretty good.

Their full report is only available to subscribers so I’m guessing the recessionary behaviour of stock and bond markets is a key contributor to this call. And what bothers me is that financial markets are responding primarily not to economic but to political developments. Europe’s perverse insistence on austerity, stemming from a wholly erroneous diagnosis of the cause of its crisis (as this article from The Economist succinctly notes), coupled with doubts about their banks' ability to withstand sovereign bond losses, is pushing the continent’s economy into a completely unnecessary recession.

In America, the biggest policy-related threat is the fiscal tightening that will happen automatically in the next four months as prior stimulus expires and legislated cuts to discretionary spending bite. Barack Obama has proposed $447 billion in new or renewed stimulus to neutralise that threat, but it requires an ambitious deal in Congress’ super committee, and odds of such a deal by its November 23rd deadline are shrinking. Democrats are reportedly trying to get it to consider tax hikes immediately, and Republicans are apparently saying that puts a big deficit reduction deal out of reach.

A global economy with decent cyclical fuel and no obvious imbalances is being betrayed by politics. Policy has pushed us over the brink in the past when it was for our own good (ie, inflation was threatening). If it happens now, it will be the first recorded instance of it happening by obduracy instead of by choice.
And we know who has been an obdurate cheerleader on austerity around the world, don't we?