What is the Case for the World Economy’s Defense as Recession Fears Rise?

Maurice Obstfeld hasn’t been chief economist at the International Monetary Fund for a full month yet and he’s already being asked if a worldwide recession is looming.

“Global recession is certainly not our baseline scenario,” he said in response to a reporter’s question on Tuesday as he cut the IMF’s estimate of growth this year to 3.1 percent, the weakest pace since 2009.

Others are less confident. They’re eyeing the China-led slowdown inemerging markets and falling commodity prices, while worrying that even the U.S. is vulnerable to foreign economic forces and that central banks now lack the power to fight back.

Just hours after Obstfeld spoke, Citigroup Inc. economists were warning that “continued sub-par growth is likely to put the global economy back into recession.” They’ve already penciled in a 55 percent probability of such an event in the next couple of years.

The relatively good news for finance ministers and central bankers gathering in Lima for the IMF’s annual meetings is that most economists are siding with Obstfeld and advising investors not to panic about the economic outlook.

Historical Guide

“We are struck by the negative spin many commentators are putting on recent developments,” Ethan Harris, co-head of global economics research at Bank of America Corp., said in an report to clients last week.

His review of past worldwide recessions finds they’ve been caused by three things, none of which are a present danger. Central banks aren’t fighting inflation, commodity prices aren’t surging and the U.S. economy isn’t facing serious problems.

The global economy was previously able to withstand the Latin American banking crisis of the 1980s, currency turmoil in Europe and Mexico in the early 1990s and Europe’s more recent fiscal woes, Harris said as he noted that “history is on our side.”

What about contemporary risks such as the slump in emerging markets in a world they hold greater sway, or a lack of room for central banks to inject more stimulus?

Calm Down

Again there is some reason for calm.

While developing nations now account for about 35 percent of global gross domestic product, exclude China and they’re still on course to grow 2.5 percent this year, according to BofA. Even though growth has disappointed in such economies every year since 2011, the world has plowed on.

As for China, Alan Higgins, U.K. chief investment officer at Coutts & Co., says the nation’s woes aren’t contagious given that its exports only contribute about 3 percent to global GDP, and about half of those are components that the receiving country ships back out again in finished products. Beijing is also stepping up its response, cutting taxes on vehicle purchases and reducing the minimum down payments for first-time home buyers.

There is still momentum in developed markets. Fiscal austerity is showing signs of fading, Greece’s problems are now ring-fenced, banks are lending more and the slide in commodities should boost consumption and investment.

Don’t Fight

Recent disappointing data such as the news that American employers added just 142,000 workers in September “doesn’t mean recession in the U.S. and Europe,” saidDavid Hensley, director of global economics at JPMorgan Chase & Co. “It means you’re moving close to trend growth rates, rather than moderately above trend.”

And not everyone is worried that central banks are turning impotent after almost a decade of easy monetary policy.

Joachim Fels, an economic adviser at Pacific Investment Management Co., argued in a report on Tuesday that even if the Federal Reserve raises interest rates this year, its counterparts in Europe, Japan and China are all set to cut borrowing costs or do more quantitative easing that will rally asset markets.

“While there are reasons to expect less bang for each QE buck than in previous episodes, the returns should still be positive,” said Fels. “It’s a monetary loser to try to fight the — global — central bank.” Source: Bloomberg