Keith Wade of Schroders tells Neal Underwood his reasons for suggesting the recovery will be short lived.
Q. Where are we in the economic cycle?
A. We [Britain] are technically out of recession because the economy has been growing. We are in the early stages of a recovery if we are putting it in a cyclical framework.
The National Bureau for Economic Research [NBER] announced that the US recession officially ended in June 2009. The economy troughed in that month and the expansion began. While it may seem incongruous that academics at the NBER are making such an announcement at a time when markets are focused on the risk of a double dip – it certainly provides a measure of the impact of the financial crisis.
Activity peaked in December 2007 thus making the last recession 18 months in length and the longest since the second world war, just ahead of the downturns in 1973-75 and 1981-82. In terms of lost output it was also the most severe during that period. Real GDP fell 4.1% compared with 3.2% in the 1970s and 2.6% in the 1980s.
Q. You think the next recession may be sooner than we think. What is your rationale behind this?
A. After the deepest and longest recession in post-war history one might have thought that an extended period of expansion was on the cards. Concerns about structural unemployment and the growth of demand suggest we are in for a shorter, more volatile expansion. On this basis, even though we continue to forecast growth for the rest of this year and 2011, the next recession may be closer than expected. With the Federal Reserve becoming concerned about inflation being too low, the tightening cycle, when it comes, could be short lived.
We’re not forecasting a double dip in terms of a quick return to recession. What we’re arguing is that the recovery is much more driven by the corporate sector than other cycles. The consumer is still deleveraging so consumer spending is in the doldrums. The corporate sector is in a good place at the moment and should be able to provide more spending but it is more volatile than the consumer – it can be plus or minus 20%. We probably see a bit of a revival in capital expenditure, but this could well run out of steam in a year or so and the economy would run out of steam again.
We are in a world much more driven by the business sector and animal spirits. The ability of the authorities to offset the business cycle has been considerably reduced. Monetary policy is not working, and the tools policymakers would normally use are not there. Should we see a slowdown, the tools are not really there. (article continues below)
Q. Are there any other contributing factors?
A. The other factor in the background is the risk of deflation, which is more unique to this cycle. This is less of an issue in the UK, but in the US and parts of Europe inflation is low and could well fall further. This does cause a concern. It could cause consumer spending to weaken quite considerably. That is a risk. There is lots of spare capacity in the world economy, which indicates inflation will stay low for some time. Lack of demand also forms part of the deleveraging story.
On a global basis consumer deleveraging removes consumer demand. In the past, for example, China was a big supplier of that demand. Now we are seeing weak consumption.
Q. Are we likely to see shorter cycles?
A. We believe this recovery will be considerably shorter than those in the past. When you look at the history of cycles, the last three have been the unusual ones. If you look at the data going back to 1854, the norm was much shorter cycles.
We are going back more towards that than the last 30 years or so. Rather than the economy expanding until inflationary pressures rise such that policy tightening brings an end to the cycle, we are more likely to see cycles ending as demand slows, either naturally through the ebb and flow of the investment cycle or as a result of an external shock.
Q. When might the next recession occur?
A. It is probably a couple of years away. This is consistent with getting the maximum strength from corporate spending coming through. Companies also might decide to do merger and acquisition activity which means they will not spend as much as we hoped. In a year’s time fiscal tightening could be biting. Perhaps we might hang on a bit, but it does not take much. The economy is not as robust as it was.
Q. How can this possibility be reversed?
A. The last tool is quantitative easing. I am of the view that it does not have a big effect on the economy. In terms of the real fundamental factors I do not think it has had a real impact. It is a difficult one.
What we are saying is, underlying it all, an adjustment has to be gone through. Central banks can cushion that to some extent but the consumer must deleverage and banks must rebuild balance sheets. I am not a double dipper but I think this is the new reality that we are in. We do not have the normal recovery mechanisms.
Q. In Britain, can the private sector absorb public sector job cuts and what are the implications of this?
A. Despite the gloomy outlook, we do think so, even on pessimistic assumptions on private sector job growth. We believe that the private sector can create enough jobs not only to cover the public sector job cuts, but also to ensure unemployment falls over the coming years. Falling unemployment means increased incomes for the household sector overall, which should support private consumption growth. However, we continue to expect a sub-trend recovery where households hold back spending as they continue to deleverage, and struggle to access new credit.
Q. What lessons were learned from the last recession?
A. In many ways the speed of the response has been right. The way policymakers are looking at it is we have to regulate the financial sector in a way which does not get us in this position again. A lot of it will switch to focus on the regulators. Central banks can also implement some macroprudential policies. At the end of the day – do not get into this situation in the first place. I think people will learn some lessons; things tend to last a generation.