Over the edge: a severe recession looms
America and Europe appear to be heading for severe recessions
AS RECENTLY as a month ago, there were still hopes that America and Europe might just pull back from the precipice of a recession. Those hopes have been dashed. The economies of the rich world seem to have fallen off a cliff. The question now is the height of the drop.
|The wheels come off|
Central banks are trying to cushion the fall. On October 29th the Federal Reserve lowered its target for the federal funds rate to 1%, matching the trough it reached in 2003. It may cut again. With remarkable speed, worries have shifted from inflation, which is still around 5%, to deflation. Fed officials still think that, if even pessimistic forecasts came to pass, inflation would not fall below zero. But Macroeconomic Advisers, a forecaster, now reckons that core inflation will fall to 1.3% by 2010, too close to zero for the Fed’s comfort. They expect the Fed to cut the federal funds rate to 0.5% in December and then, with scant room for more cuts, that it may try to stimulate growth using unconventional measures such as further expanding its lending facilities to banks and other firms.
The rate cut was needed. America’s economic data have become starkly weaker since the bankruptcy of Lehman Brothers in mid-September. The latest GDP numbers, released on October 30th, showed that output fell by an annualised 0.3% in the third quarter. Surveys of manufacturing activity have shifted down. Weekly initial claims for unemployment benefits have shot up. A monthly index of consumer attitudes compiled by the Conference Board, a research group, plummeted to a record low of 38 in October, down from 61.4 in September.
Confidence surveys are unreliable predictors of consumer spending. But the destruction of wealth through falling stockmarkets and tightening credit conditions are already having an effect. On a seasonally adjusted basis, light-vehicle sales in September were the lowest since 1992, according to Autodata Corp, a research firm. On October 28th Whirlpool, an appliance maker, gave warning that low home sales would cut revenue and Royal Caribbean Cruises, a cruise operator, lowered profit estimates because of “a significant deterioration recently in new bookings”.
A similar downward lurch is under way in Europe, where the European Central Bank seems poised to cut interest rates for the second time this autumn on November 6th. The Munich Ifo Institute’s index, which measures the mood of German businesses, sank to its lowest level for more than five years in October. Volvo wins the prize for statistic of the crunch to date. The Swedish firm said it had received a mere 115 orders for heavy trucks in Europe in the third quarter, down by 99.7% on the 41,970 order bookings during the same period of 2007.
America and Europe cannot count on exports to make up for faltering domestic demand, because the crisis has spread to emerging markets. Airbus and Boeing, for example, had counted on orders of 300 aircraft from India in the next five years to help offset slower demand in Europe and America. Some of those are in jeopardy. Jet Airways, India’s largest domestic carrier, announced its biggest quarterly loss in more than three years on October 25th.
Economists disagree about how bad it will get. Dean Maki of Barclays Capital says that falling wealth tends to affect consumer spending over many years rather than right away. It is just the opposite with changes in real income because of petrol prices. Consumer spending could conceivably be lifted by the sharp drop in oil prices that has unfolded since July, which Macroeconomic Advisers estimates to be worth more than $100 billion on an annualised basis. Mr Maki notes that consumer confidence plunged after the September 11th terrorist attacks but that Fed rate cuts enabled interest-free loans which dramatically boosted car sales. Another small positive sign is that home sales rose slightly in September and that house prices have actually risen in a few cities.
These glimmers may be snuffed out by the unprecedented tightening in credit now under way. According to Ed McKelvey of Goldman Sachs, the only comparable modern precedent is the federal government’s short-lived imposition of credit controls in early 1980, which produced a dramatic downturn in American consumer spending. That episode ended when controls were removed. Today, credit restraint chiefly depends on how long it takes the private sector to respond to policy actions such as the Fed’s commercial-paper purchases and the widespread recapitalisation of weakened banks. “Government is working as hard as it can, but in the end it’s the private sector that does the lending,” he says.
From The Economist print edition