From UPSC perspective, the following things are important :
Prelims level : Nothing much
Mains level : Global economic slowdown - options ahead
There are growing fears of a global recession at the moment and there are three negative supply shocks that could trigger it by 2020.
Potential reasons for a global recession
- Trade war: Sino-American trade and currency war escalated when the US administration threatened additional tariffs on Chinese exports and labeled China a currency manipulator.
- Technology war: China and America are vying for dominance over the industries of the future: Artificial Intelligence (AI), robotics, 5G, etc.
- Oil supplies: If America’s confrontation with Iran escalates into a military conflict, global oil prices could spike and bring on a recession, as happened during previous West Asia conflagrations in 1973, 1979 and 1990.
Impact of a recession
- All of these potential shocks would have a stagflationary effect.
- There could be an increase in the price of imported consumer goods, intermediate inputs, technological components, and energy due to reduced output by disrupted global supply chains.
- The conflict between the US and China is already fueling a broader process of deglobalization as countries and firms cannot count on the long-term stability of the integrated value chains.
- Trade in goods, services, capital, labor, information, and technology gets increasingly balkanized and global production costs will rise across all industries.
Are we prepared to tackle this
- Following the stagflationary shocks of the 1970s, monetary policymakers responded by tightening monetary policy.
- Today, major central banks are already pursuing monetary-policy easing, because inflation and its expectations remain low.
- Any inflationary pressure from an oil shock will be seen as merely a price-level effect, rather than as a persistent increase in inflation.
- But negative supply shocks will reduce both growth and inflation by depressing consumption and capital expenditures.
- Firms in the US, Europe, China, and other parts of Asia have cut down capital expenditures and global tech, manufacturing, and industrial sectors are already in a recession.
- As private consumption is still strong, this hasn’t resulted in a global slump yet.
- If the prices of imported goods rise further, real disposable household income growth would reduce and the global economy may enter into a recession.
- Central banks should ease policy rates.
- Fiscal policymakers should also prepare a similar short-term response. There is a need for a countercyclical fiscal easing to prevent the recession from becoming too severe.
- In the medium term, adjusting to the negative supply shocks without further easing could be the solution. Because negative supply shocks from a trade and technology war would be more or less permanent.
- Such shocks cannot be reversed through monetary or fiscal policymaking. Attempts to accommodate them would eventually lead to both inflation and inflation expectations rising well above central banks’ targets.
- There is an important difference between the 2008 global financial crisis and the negative supply shocks that could hit the global economy today.
- The former was mostly a large negative aggregate demand shock that depressed growth and inflation. So it could be met with fiscal and monetary policies.
- But this time, the world would be confronting sustained negative supply shocks that would require a very different kind of policy response over the medium term.
- A supply shock is an event that suddenly increases or decreases the supply of a commodity or service, or of commodities and services in general.
- In economics, a recession is a business cycle contraction when there is a general decline in economic activity.