Issues related to Economic growth

[op-ed snap] The anatomy of the coming recession and our options

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Nothing much

Mains level : Global economic slowdown - options ahead

CONTEXT

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

  1. 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. 
  2. Technology war: China and America are vying for dominance over the industries of the future: Artificial Intelligence (AI), robotics, 5G, etc.
  3. 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

  1. All of these potential shocks would have a stagflationary effect.
  2. 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. 
  3. 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. 
  4. 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

  1. Following the stagflationary shocks of the 1970s, monetary policymakers responded by tightening monetary policy. 
  2. Today, major central banks are already pursuing monetary-policy easing, because inflation and its expectations remain low. 
  3. Any inflationary pressure from an oil shock will be seen as merely a price-level effect, rather than as a persistent increase in inflation.
  4. But negative supply shocks will reduce both growth and inflation by depressing consumption and capital expenditures. 
  5. 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. 
  6. As private consumption is still strong, this hasn’t resulted in a global slump yet. 
  7. If the prices of imported goods rise further, real disposable household income growth would reduce and the global economy may enter into a recession.

Policy

  1. Central banks should ease policy rates. 
  2. 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.
  3. 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. 
  4. 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. 
  5. 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. 

 

Back2Basics

  1. 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.
  2. In economics, a recession is a business cycle contraction when there is a general decline in economic activity.
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