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Waiting for the next downturn

The current global economic expansion continues more-or-less unabated but the potential causes of the next downturn seem clear. Commentators see an escalation of trade tensions between the US and China as the main threat. Other potential hazards that are commonly identified are political developments in Europe, difficulties with the end of quantitative easing and a hard landing in China.

Perhaps one threat that is not discussed enough is a sudden, uncontrolled rise in inflation. There are no clear-cut reasons to expect inflation to surge in any large economies but, as some economists argue, it is possible in the coming decade. Wage pressure has started to manifest itself in the US, much later in the cycle than usual, and it is starting to become apparent in Europe too, earlier than expected. 

Speculating on when and how the next recession will occur might seem pointless but it is the starting point of a more useful discussion. When the cycle turns, it is unlikely the next recession will conform to the standard definition of two consecutive quarters of falling GDP. It will not be mild; on the contrary, it is likely to be severe. 

First, it will be a global affair. A slowdown in the US would affect other economies that are already fragile, such as the euro-zone and some emerging economies. China, which is engaged in a complex transition from a resource-based, export-driven economy to one based on technology and consumption, would not be insulated from economic stress.

Second, and most importantly, central banks around the world, including the US Federal Reserve, will not be able to provide significant stimulus. With interest rates at such low levels, preventing an inflation shock from derailing the economy would prove almost impossible.

The underlying reason why the global economy cannot be expected to shake off the next downturn easily is apparent. The global financial crisis exposed the long-term structural weaknesses of the world economy and these have not been addressed to a significant extent. 

“The next recession will not be mild; on the contrary, it is likely to be severe”

The crisis can be seen as a turning point in the global economy, after which the woefully poor productivity growth in developing economies became a problem that could no longer be ignored. 

The continued increase in global debt, which has not been tackled despite the problems it created before and after the recession, is another challenge that deserves close scrutiny. 

Until these problems are addressed, do not expect the global economy to follow a harmonious path. 

Carlo Svaluto Moreolo, Senior Staff Writer
carlo.svaluto@ipe.com

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