New Global “Soft Patch” or the Beginning of a “Deep Murky Swamp”?
While markets are waiting for the third quarter US GDP figures, everyone’s attention is now concentrated on the fourth quarter and 2005 growth prospects for the US and the global economy. In Q3 the US recovered from the Q2 soft patch (as GDP growth is expected to end up in the 4% range for the past quarter); but now, with oil prices above $50, the concern is not any more that we are in a “soft patch” but rather falling in a deep murky swamp of global growth slowdown. The most alarmed are folks such as Steve Roach who is now predicting that the US , Europe and Japan will reach a stall speed of 1.5% growth by the beginning of 2005. And indeed the US flow of macro news has been poor: continued weak job numbers in september, falling consumer confidence while retail sales are holding, falling housing markets, weak industrial production, slow income/wage growth, increased inventory build-up, soft durable goods figures, large and growing trade deficit, mixed signals from inflation (with now core up more than expected).
And if we were to enter a swamp, there are no policy easing options available in the US as monetary policy needs to tighten, fiscal policy needs to tighten even more (given the ugly fiscal deficit) and the $ dollar cannot head much more south as long as the Asians keep their pegs (and Euro and Yen have already done most of their fair share of adjustment).
Alan Greenspan is saying do not worry about oil but Trichet and the Europeans are getting real worried that oil above $50 will clip the already dismally low European growth (see the alarm from the Morgan Stanley Euro team); and Japan, even more dependent on oil than Europe, is also slowing down. The argument that a 10% increase in oil prices reduces global growth only by 0.3% or so may turn out to be too optimistic. Even supply siders such as John Makin are sounding an alarm bell (in the WSJ yesterday) and asking Alan to stop tightening rates.
As discussed in my recent paper with Brad on oil and the global economy, there are good reasons to believe that the effect of the oil shock will be larger than commonly expected.
Afterall, the last four U.S. and global recessions in the last three decades have been associated with oil price shocks driven by political shocks: the Yom Kippur War of 1973 led to the global recession of 1974; the Iranian Revolution of 1979 led to the recession of 1980; the 1990 invasion of Kuwait by Iraq led to the 1990-91 recession; and part of the late 2000 slowdown and 2001 recession was exacerbated by the 2000 oil shock where Middle East tensions (the second Palestinian intifada) and other factors led to a spike in the oil price in late 2000. Even the spike in oil prices in early 2003 (right before the latest Iraqi war), while not causing a recession, contributed to the significant economic slowdown of the first half of 2003.
Yes, we are sort of less dependent on oil than in the 1970s; yes, real oil prices are lower now than in the two 1970s shocks; and yes, crebible central banks can ensure that the oil shock will not lead to higher inflation. But the corollary of that is that the effect of the oil shock will go more into quantities (output) than into prices; thus, the growth slowdown may be more significant.
Thus, there are good reasons why this latest oil shock may have a larger impact on growth than expected by most. What matter is not just the direct stagflationary effect of this supply shock; its effect on consumer and business confidence and, thus, on aggregate demand are also important. And a debt-overburdened low-saving US consumer with little job or wage or income growth and with security concerns (from Iraq to Iran to North Korea to terrorism) may soon decide to retrench. I fleshed out the arguments in more detail in my recent paper with Brad Setser “The Effect of the Recent Oil Price Shock on the US and Global Economy” (August 2004).
In conclusion, the effect of oil shocks has been underestimated in terms of their impact in the past; and they may be underestimated again today by central bankers and wishful thinkers.
4 Responses to “New Global “Soft Patch” or the Beginning of a “Deep Murky Swamp”?”
October 21st,2004 The effects of oil prices increases, may also depends of what finally happens with relative prices.Increasing globalization is pushing down some prices,specially those coming from China manufacturers.So, the final effects will depends on the share each of this items count on domestic price level .On the other hand ,strong commitment by Central Banks to keep inflation under control ,gives some room to transitory increase on the spot inflation rate ,as long as the tendency inflation rate is downwards.In other words ,there is still the chance to keep easy monetary policy a little while longer. The real effect may be on the consumer and investor confidence.On this side, there is no counterbalanced effects. Best regards Erico Wulf
We must remember that oil is not just something we refine gasoline from. It is used in every component of our lives–from the plastic this keyboard is made from to fertilizer and heating oil. There is only so much the economy can absorb before this “tax” has a terrible effect on the US and global economies. I feel that this will pressure corporate earnings–I do not see how it cannot. I also see inteerest rates remaining in a lower range as a result.