Economy: Recession – Or Not?

The downside risks for the U.S. and Georgia are high and will remain elevated for an extended period of time. A slow-growing economy typically does not stop growing on its own. With the EU’s financial system still under considerable stress and little momentum in terms of U.S. Gross Domestic Product (GDP) growth, however, the risk that a negative external shock or a major policy mistake will tip our economy back into recession is 40 percent for the U.S. and 45 percent for Georgia.

A full-blown financial crisis fueled by the government debt crisis in Europe is the biggest risk to economic growth. The EU is already in recession, which will hammer our exports and cut into U.S. corporations’ overseas profits. Even worse, the possibility of contagion from European financial markets to U.S. financial markets is quite high.

  A resurgence of political turmoil in the Middle East and North Africa is a credible risk because it could lead to oil supply interruptions and substantially higher prices. The U.S. and Georgia economies are growing too slowly to absorb a major oil price shock without tipping into recession. Most outside shocks, however, are difficult to recognize in advance.

Historically, policy mistakes rather than outside shocks are the primary causes of double-dip recessions. Given the political climate, there is a considerable risk that U.S. fiscal policy will be tightened too aggressively. More-over, political concerns might cause the Federal Reserve to act too slowly or to otherwise limit its policy options.  

Low confidence alone could cause job growth and the recovery to fizzle. Last year, consumer confidence was already in recession territory. It is not difficult to make a case for a downward spiral in confidence, spending, hiring and inflation-adjusted GDP.

The federal fiscal situation has worsened dramatically over the last several years, offsetting much of the beneficial – albeit painful – deleveraging in the private sector. Very little progress has been made towards reducing imbalances associated with fiscal deficits in several European countries. High debt-to-GDP ratios will limit fiscal policy options in many developed economies and could easily lead to excessive tightening of fiscal policy. 

Fiscal imbalances in the U.S. and other developed economies have grown in the wake of the Great Recession and constitute a significant risk to the stability of financial markets and economic recovery. 

The outcome of re-clogged credit markets would be another leg to the housing downturn, but it would be much less intense than the previous downturn because the remaining imbalances are considerably smaller.

As credit gets scarcer and corporate profits dive, even long-term capital spending projects would be scaled back. Foreign economic growth would be much lower. Since the shocks themselves would be deflationary, the Federal Reserve would ease, but it has already eased very aggressively. Thus, there is precious little ammunition left for further monetary largesse. Indeed, the Federal Reserve’s actions have reached the point of diminishing returns.

For the U.S. and Georgia, a recession in 2012 or 2013 would probably be much milder and shorter than the Great Recession, because the main imbalances in the private sector have been fully or substantially corrected. Housing has corrected, non-residential real estate has mostly corrected; and the current account deficit and house-hold balance sheets have partially corrected.

Overpriced property-type assets have been substantially re-priced. In many markets, home prices may have declined too much relative to long-term market fundamentals. In addition, corporate balance sheets – outside of the financial sector – are absolutely pristine. The Fed’s monetary policy is already extremely accommodating.  

The economic recovery is vulnerable to another oil price shock. A significant interruption in supply could make energy prices climb dramatically. A second energy crunch stemming from major supply interruptions rather than robust demand growth would terminate the recovery and temporarily push up core inflation – a description of stagflation. Georgia would be particularly vulnerable due to its large transportation, distribution and logistics industry as well as long commutes in the Metro Atlanta area.