The Economist magazine’s annual special section on the world economy this year focuses on the impact “toxic politics and constrained central banks” will have on the next downturn. They find that “the rich world in particular is ill-prepared to deal with even a mild recession. This is partly because the policy arsenal is still depleted from fighting the last downturn.” Marketplace’s Sabri Ben-Achour spoke to Economist editor Henry Curr about the state of the world economy.
Below is an edited transcript of their conversation.
Sabri Ben-Achour: The picture you guys paint is one in which the world’s economies and central banks are all pulling in different directions. In the U.S., the government stimulated the economy with the tax cut and spending and now the Fed has to cool things down. Meanwhile in Europe and Japan, they’re still trying to warm their economies up, a lot of emerging markets are a mess – put this all together and you guys say we might get a recession in a couple of years.
Henry Curr: Yes, that’s the risk. So among major advanced economies, for instance, if you look at the IMF forecasts, every major advanced economy was forecast to slow this year except America, which was forecast to speed up. And so the question is when America slows – which is likely as the tax cuts begin to wear off and as the Fed’s tightening begins to bite – will we then have a global downturn? I think that’s the question everyone’s trying to think about.
Sabri Ben-Achour: Well, if that happens, you argue that the rich world in particular is ill-prepared to deal with even a mild recession. Why is that?
Henry Curr: The fundamental problem is that interest rates are still too low even in America where rates have gone up eight times now since the Fed started raising rates in December 2015. You’ve only got about 2 percentage points worth of cuts, so if you look back at the history of recessions in the 20th century, typically the Fed would cut interest rates by more like five or six percentage points. So the Fed and other central banks are going to be depending on quantitative easing, that’s where central banks buy financial assets like government bonds with newly created money. And there’s more debate than the central banks like to admit around quantitative easing’s effectiveness. And also it’s a controversial policy and it was controversial the last time it was used. So they might run up against more scrutiny when they do that. So that’s the fundamental issue, that interest rates still remain low and yet we may have a recession in the next few years.
Sabri Ben-Achour: In the last recession – countries, treasuries, central banks – they all really had to cooperate internationally to deal with that disaster. There are these days a lot of populist anti-globalist governments gaining strength. Is that a problem for the next recession?
Henry Curr: Yes I think it is. And I think it’s a problem in two respects. The first one is trade. So when you’re in a recession, criticisms of trade deficits that are made by populists and by the likes of President Trump become more economically accurate because there’s a limited amount of spending in the world. So if you can kind of keep that spending on your own products and try to avoid imports and avoid trade deficits, that might actually boost your economy. So this is kind of a bad temptation to resort to protectionism even though if everyone does that, that’s very bad for the world and that’s what happened in the 1930s.
The second risk is with regard to international cooperation. And the problem there is that during a crisis, central banks often want to cooperate across borders. So in the last financial crisis, the Federal Reserve opens so-called swap lines, which allowed the Fed to lend dollars to foreign central banks in return for their currency – that’s why it’s a swap line – as collateral for those loans. And the reason the Fed was lending dollars to foreign central banks is because a lot of foreign finance actually is dollar denominated, they’re large offshore dollar markets. So you can imagine in an age of populism there being more questions asked about whether or not central banks should be lending across borders to foreigners or whether they should be focusing on their own domestic economies. So that kind of international cooperation gets harder and that’s a problem, particularly with regard to the dollar financial system because there’s a lot more dollar finance now happening outside America than there was a decade ago.