US economy

Latest US spending programme could tip country into a recession. Getty Images

By John H. Makin and Daniel Hanson

An abrupt spending sequester at a rate of about $110bn per year ($1.1tn over 10 years) scheduled to begin March 1 could cause a US recession, coming as it does on top of tax increases worth about 1.5 per cent of GDP enacted in January. The April deadline for a continuing resolution to fund federal spending could lead to a fight that shuts down the government, placing a further drag on growth.

These ad hoc measures, aimed at creation of an artificial crisis, will fail to produce prompt, sustainable progress towards reduction of “unsustainable” deficits because deficits have been, and will continue to be for some time, eminently sustainable. The Chicken Little “sky is falling” approach to frightening Congress into significant deficit reduction has failed because the sky has not fallen. Interest rates have not soared as promised and, in fact, interest costs for the federal government have remained steady at a tiny 1.5 per cent of gross domestic product since 2002, having fallen to that level from a 3 per cent average during the decade prior to 1997. Read more

Shankar Acharya

By Shankar Acharya

What might 2011 hold for us? Given the intrinsic uncertainty about the future, the really honest answer would be: I don’t know. But that would be far too boring a response and, perhaps more to the point, would not fill a column. So, at the risk of looking foolish in a year’s time, here are some predictions for 2011. Read more

by Peter Boone and Simon Johnson

The US government has moved dramatically, in what it argues is a comprehensive manner, to counteract serious problems in the financial system, and to reduce the risk of a serious recession or worse.  Eurozone policymakers are far more reluctant to intervene.  They remain inclined to handle growing bank failures on a case-by-case basis; and, while their central banks have provided liquidity, they have avoided using other fiscal and monetary policy tools.  If the fortunes of the world economy depended only on the US policy response, we would predict just a fairly severe recession.  The absence of any indication that there will soon be a decisive European policy response suggests we could be in for something considerably worse.

In the view that is increasingly prevalent in the US, we are not facing a Keynesian demand recession, nor the supply side shocks of the 1970s. It is a crisis of confidence very similar to the Asian crisis of 1997-98.  The lesson from these events is when trust in highly leveraged financial markets weakens, there can be long and enduring repercussions across all sectors of the economy. The Federal Reserve’s implicit policy model since September 2007 appears to be tied in part to those events.

In contrast, the frame of reference for European authorities appears to be drawn from the lessons of the 1970s.  They are concerned about inflation and second round effects from past commodity price rises, so they keep interest rates higher.  They have not announced national programmes to bail out financial institutions and borrowers, in part, because of perceived costs relating to future moral hazard. Read more