The evidence for the upcoming recession!

(c) Guity Novin

These posts have been interrupted for a number of reasons.  Nevertheless, I must add that, had  they continued uninterrupted their information contents would have been severely limited. This is  because  the election of President Trump and his unconventional approach to economic policies have introduced a paradigm shift, reducing substantially the signals-to -noise ratio of many economic models.  It should also be added that there were other unusual noise-creating events in Europe, including  Brexit, the financial situation in southern Europe; particularly with regard to the  Italian debt problem, and finally the geopolitical and trade tensions.

Many of these sources of uncertainty are still unresolved, but one has a bit of more clear perspective with regards to  their possible trajectories.  Of course, as many commentators have already mentioned the 4.1percent growth in the second quarter is just a one-quarter- performance of economic growth, and it is not reasonable  to consider it as signifying the emergence of an upward sloping economic trend.  In other words,  the growth may not be sustainable.

Of course,  the  global economy has gone  through a synchronized  recovery in its major economies, mainly stimulated by a very expansionary monetary policy -- that its adverse impacts are somehow disguised by the increased noise in the data.This note will argue that based on some theoretical guesses  the probability of a sharp economic slowdown has increased by an order of  magnitude. There are reasons to believe that the short-term aggregate supply curve and the long term potential have began to shift to the right, while because of "borrowing  from the future" and large budget deficit  the aggregate demand will shift to the left. The result would be the onset of recessionary forces that their amplitude  could be wider than the previous one in 2008-09.

Aggregate Short-run Supply and Long-run potentials have began to shift to the right:

A shift to the right of  the aggregate short-run supply curve is usually stemming from declines in costs of production, which are induced by technological progress.  However, the shift this time has its origin in some increased trade policy noise. In particular, the U.S. administration's protectionist trade policies including the proposed 10 percent tariff on $200 billion in Chinese goods,  and its predecessor of $50 billion of  tariffs on imports from China have disturbed the equilibrium conditions  in the associated markets, providing incentives for some entrepreneurs to enter into the markets to substitute the imported supply from China-- i.e.,   a shift of the short-term aggregate supply to the right.  This would have been positive had the Say's law that 'supply create its own demand'  would have been operative, which we would argue it wouldn't happen  in the current circumstances.

 A  50 per cent reduction in the value of imported goods from China last year, and the expected  retaliatory  measures by China  would, of course, be of major adverse consequences for employment and demand, which will be exacerbated by the increasing  production costs due to the imposition of tariffs -- more on the demand shift later in this article.

Furthermore, the rightward shift in the Short Run Aggregate Supply is enhanced by corporate tax cuts, which are also expected to simulate business spending on capital and equipment. In fact, companies have already started to invest again. Unfortunately, a well established prediction of the economic theory is that tariffs would distort the nature of such investments. This is because relative price signals would be sending wrong information about the prospects of goods that are relatively inferior, aginst the goods that would enhance the competitiveness of the economy. Thus investors invest in wrong projects, a mistake that many less-developed countries committed during 1950-60s. 

 It is easy to see that as a result of these capital expenditures, the long-term potential would transiently shift to the right.

A Shift of Aggregate Demand to the Left

  We have already mentioned some reasons for the expected leftward shift in the aggregate demand. However, the main force behind this expected shift would arise from  a necessarily drastic fiscal tightening in order to reduce the budget deficit, which according to the Congressional Budget Office estimates would be about $1tn over the next fiscal year. The uncertainty, unleashed by these cuts would, of course, exacerbate the consumer entrenchment and the leftward shift in aggregate demand,.

Both rational businesses and consumers, anticipating a rising prices due to tariffs have began to "borrow from future"  i.e., buying consumer and capital goods  before tariffs take effect and raise the prices of those goods. The halt of these purchases  during a fiscal tightening period would remove  their stabilizing effects and would aggravate  the uncertainty.

Of course, the impact of tariffs on prices in the short term would cause an upward movement along the aggregate demand curve which would be adding to the complexity of the  gauging  the magnitude of the leftward shift in  aggregate demand by policymakers.

Global Economy

According to World Bank forecasts global growth this year will reach 3.1 percent, as compared to about  3 percent rate for 2017. The growth is expected to be mainly concentrated in emerging economies, which will be rising to  4.5 percent  this year relative to 4.3 percent in 2017. This global growth pattern does not bode well for the sustainability of global growth,  as it emanates  from a greater sensitivity of emerging markets to advanced economies growth-- which itself is  a consequence of the export-led-growth strategies of these countries. This situation is exacerbated by the trade wars with China,  a country that would be unable to reduce her  burden of debt, now at about 260 percent of national output, with a shrinking global trade.

 Meanwhile, central banks need to refurbish their monetary policy instruments in order to be able to fight the upcoming recession. In other words they need to raise interest rate - for the ironic reason that this would enable them to reduce them by a sufficient amount that could provide  effective stimulus in a fight against the expected recession. Recall that the  current recovery has been fostered by the extraordinary monetary expansions of the Federal Reserve, ECB and Bank of Japan, which included negative interest rates via expansion of their balance sheets by purchase of risky  assets on a massive scale.