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Brendan Keenan: 'There is no science to forecasting recessions - or how bad they will be'


(stock image)

(stock image)

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(stock image)

The semi official international forecasters, the International Monetary Fund (IMF) and the OECD, received a deal of flack for not spotting the great recession coming in 2008. Even Britain's queen Elizabeth said as much to one of their representatives at a formal event. The lesson to draw is not to ignore their prognostications, but to read them carefully. Apart from the fact that they are creations of government, there is no science for forecasting when recessions will arrive - even though they appear to be an inevitable part of economic life.

Worse, there is no precise indicator of how bad they will be; sometimes surprising on both the upside and the downside, as the saying goes. So predictions of actual downturns, to say nothing of crises, do not appear.

They still should have made more of the borrowing binge of the 2000s - especially in Ireland, where there was not even the excuse of the banks using complex products which no one really understood.

But careful reading of their reports would have given any intending borrower food for thought, and should have paused politicians and interest groups in their gadarene rush for a chunk of the pie.

This would have meant paying more attention to the range of possible dangers contained in IMF and OECD reports, along with the historical examples of what happened after past debt bubbles, and a bit less to the overall conclusions.

Last week, the IMF published its annual World Economic Outlook. Careful reading is again required but there may not be much help from past experience this time. Unlike property bubbles, there are no real parallels to the current situation.

The glaring difference from the past is the level of interest rates and central bank monetary policy. History is no guide, but the warnings from the IMF of what this might mean are more stark than were those about the debt bubble.

A key phrase is the Fund's description of the global economy as being "in a synchronised slowdown", with world growth easing in both the rich and emerging economies. This means another downgrade of the 2019 estimate to 3pc. It looks good at first glance, but it would be the slowest pace of global growth since the financial crisis 10 years ago.

Then comes the tricky bit of interpretation. The IMF does not see a continued downward trend. Instead, there is a modest pick-up to 3.4pc next year - a bit less than the last such forecast in April. But - and it is a big but - unlike the slowdown, this is not a synchronised recovery.

As a result, it remains precarious. The cautious investor will take those words seriously too. If there is such a recovery, it will be driven by emerging and developing economies, not the developed ones.

Even less encouraging is that about half of the improvement comes from better conditions in stressed economies such as Argentina, Iran and, ahem, Turkey. The rest are cyclical recoveries in Brazil, India, Russia and Saudi Arabia. So there may not be a recovery. The world's biggest economies - the US, China and Japan - are expected to slow further in 2020. The only reason Germany is not on that list is the steepness of its slide already, with growth falling from 2.5pc in 2017 to 0.5pc in 2019.

Economies are rarely in balance. No recovery would probably mean recession, and recession might mean crisis.

The report's long list of things which could go wrong is not matched by suggestions of what could go right, other than the turn in some emerging economies.

The IMF blames most of the downturn on the trade tensions between China and the US, compounded by crises in the Middle East. Now, the first shots in a trade war between the US and EU have been fired.

Germany's reliance on exports makes it more sensitive to global conditions and the car industry has suffered most.

That brings Brexit to mind. Brexiteers may have set too much store by German fears over what a no-deal exit would do to its industry, but one could certainly think of better conditions as a backdrop to such an outcome.

Over the medium term, the report notes, new trade barriers and political tensions may disrupt supply chains and hit the productivity growth on which general growth depends. The fear is that build-up in financial vulnerabilities, especially debt, could amplify the next downturn. This would be the classic case where there is a general flight of capital from vulnerable, usually emerging economies, but also from highly indebted banks and companies.

There are still plenty of those. The IMF reckons there could be $19trn (€17trn) of debt at risk if growth and asset prices falter. The issue occupying the minds of the great and good in economic policymaking is how to deal with such a situation when interest rates are close to zero, or even negative.

The preoccupation with Brexit and Donald Trump has obscured the extraordinary splits in the board of the European Central Bank, following its decision to continue with zero interest rates and resume buying loans from the financial system.

Sabine Lautenschlaeger became the third German director to resign over policy in the past decade. Bundesbank president Jens Weidmann criticised the policy publicly, as did the central bank bosses of most of the eurozone's richer countries.

Lesser disagreements during the euro crisis were front-page news in the financial media but, as well as all the other distractions, the same dispute has been running since the outgoing Mario Draghi became ECB president, and its news value has diminished. He won all the battles but his successor, Christine Lagarde, and the new chief economist, our own Philip Lane, are in for an interesting time.

All sides agree that persistent low interest rates have made the traditional role of central banks in smoothing the economic cycle much more difficult, even close to impossible. The Bank of England's deputy governor, Jon Cunliffe, noted that they also add to the dangers by encouraging higher-yield, higher-risk lending.

Loans to highly indebted companies are back to pre-crash levels. "This is a risk because we know that more leveraged firms cut back on investment and employment by more in a downturn," he said.

Central banks will have to do something to deal with a new recession but it is likely to be just more quantitative easing through the creation of money to buy debt from the financial sector. It is not clear how effective that would be, or whether it has become no more than a fix for debt junkies. The central banks of the big, rich countries already own loans worth more than a third of GDP.

In the strangest of twists for an Irish observer, organisations like the IMF now point to more government spending and borrowing across the globe as the best remaining weapon to fight a recession.

There is not much point in asking the country with the biggest such weapon, Germany, to wield it vigorously while all that monetary easing is going on, and any who do follow the advice will find themselves in what would once have been regarded as dangerous territory.

The IMF report calculates that average public debt in the advanced economies is now 76pc of GDP - 70pc in the euro area and 81pc in the US. Ireland looks good in such a table at 60pc, of course, but what is genuinely cheering is that debt as a percentage of the much more realistic modified national income (GNI*) has fallen to that average of 76pc.

Those are all high figures by past standards, but the present level of interest rates means that the burden on taxpayers is much less than it would have been in the past. In Ireland's case, the 2020 Budget showed interest costs at €5bn - just 2pc of GNI*. Our post-Brexit contributions to the EU are not far off that.

The implication of the fiscal solution is that debt to rise until it represents the kind of burden carried when rates were more like 4-5pc. In that event, an actual rise in rates because markets are no longer believed in this magic roundabout would spell disaster.

The dire Brexit calculations showed how quickly the debt burden would rise as a result of the recession caused by a no-deal exit in a small open economy, like Ireland's.

In the strange world we live in, it is hard to know how much extra support governments could give their economies in the event of a recession, without adding to the risk. But it is hard to believe it is so strange that there is much room for Ireland to do so.

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