October 07, 2015


The slowdown is happening, and it is not understood

It was a day when it was becoming increasingly hard to maintain the silly pretension that the eurozone would shrug off the global economic slowdown. German industrial orders fell 1.8% mom during August, while the July figure wasrevised downwards from -1.4% to a whopping -2.2%. Germany's federal statistics office reports that orders from the eurozone increased, while orders from outside the eurozone fell by 3.7%.

Note that these data do not yet take account any VW effect. VW yesterday said it would cut investment - which means it will order fewer supplies, while customers will presumably order fewer VW cars. Since the wider car industry accounts for some 7-8% of German GDP, the Volkswagen effect alone is likely to be visible in the national statistics. We expect to see a prolonged downward trend throughout the winter as a result of a confluence of various global shocks - China, VW and the car industry in general, and emerging markets. 

The IMF yesterday weighed in with its World Economic Outlook. The forecasts are meaningless - as they have been for the last ten years. We are not going to relay them here as the news media cover this in full. 

More interesting to us are the more specific analytical points, and especially the extent to which they reflect the handwriting of Maurice Obstfeld, who just jointed as chief economist.

The IMF's main analytical point is that the fall in global growth is fundamentally due to a fall in total factor productivity, which means that it is badly understood. Weak investment after the global financial crisis may have been a trigger. A box on page 51 in the report focuses on research on 100 recessions in 23 advanced economies since the 1960s showing that, in two thirds of the cases, recessions are followed by lower output levels relative to the pre-recession period. The IMF said what it finds most surprising is that, in half of the cases, the recession also led to a permanent growth effect. It is very clear from the discussion that these observed facts are not consistent with economic theory. 

The IMF looks at three potential explanations.

1. Hysteresis: Financial crises trigger institutional changes, such as tougher capital requirements, with the potential of affecting long-term output. Hysterisis is best known in the labour market where recessions causes some members of the labour force to drop out permanently. 

2. Dynamic effects of supply shocks. We quote verbatim:

"it is plausible to argue that the sharp decline in output at the start of the global crisis and the subsequent lower growth path stem from the same underlying cause—namely, the crisis in the financial system, manifesting itself through an acute effect at the start and a more chronic effect thereafter."

3. And finally, reverse causality: A recession could be partly due to the anticipation of lower growth to come, in a self-fulling prophesy. 

We were able to peruse Chapter 1 of the WEO, but not yet chapters 2 and 3. We will bring you summaries of those - to the extent that they are of interest to us - in the next few days. One of us will be attending the World Bank/IMF annual conference, so the global economy and financial stability are likely to be the dominating themes of the next few days.

Our other stories

We also cover Spanish election polls showing Ciudadanos ahead of Podemos; the surprising postponement of the Commisson's opinion on Spain's budget; the mandate to Passos Coelho to attempt a new government in Portugal, and the budget execution difficulties he will face; a comment from planet Germany on fiscal stimulus; VW's dim prospects; foot-dragging on the single bank resolution fund; and, finally, the ECB's new explicit rules for speaking engagements.

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