The U.S. and other rich-country economies may be close to “stall speed,” according to the developed world’s most prestigious economic think-tank, a rate of growth so dangerously slow that it could tip countries back into recession.
Tuesday’s gloomy prognosis by the Organization for Economic Cooperation and Development (OECD) highlights the risks posed to institutional investors by the painfully slow nature of recovery across the developed world. The conundrum of stall speed is particularly important for sovereign bond investors, as they seek reassurance on the overall viability of national economies.
Stall speed is a relatively new concept in mainstream economics. It suddenly gained credence at central banks in 2010 when the global economy’s bounceback from the 2008 crash started to subside, prompting an anguished search for reasons. It is based on the idea that slow growth generates its own negative momentum. Adherents of the principle say history shows that when output growth in a particular country slows to below a certain level, the economic consequences of that slow growth, such as unemployment, have tended to reduce growth still further — to the point where recession becomes much more likely.
“In some economies, output growth is now close to or below estimated stall-speed thresholds,” the OECD said on Tuesday in its eagerly awaited “Economic Outlook,” a twice-yearly report perused by analysts for its views on the future of global output. It cited a “risk” that “self-reinforcing” factors “could push them into outright recession.”
The report cites recent economic research suggesting that the threshold below which the U.S. economy enters stall-speed territory is between 1.5 and 2 percent. The same research puts the threshold for Japan’s stall speed at 0.5 to 1 percent.
The OECD estimates that on the basis of widely cited “stall-speed thresholds,” “GDP growth over the year to the fourth quarter of 2012 in the United States and Japan is projected be in or close to the range in which there is estimated to be a strong chance of an outright decline in GDP over the following year.” It predicts year-over-year output growth of 1.8 percent in the U.S. and 0.3 percent in Japan, in the final three months of 2012.
The intellectual explanation for stall speed is that slow growth damages an economy largely through increasing joblessness, since growth is not fast enough to prevent companies from laying off workers. Higher unemployment damages consumer confidence and the housing market. This depresses spending, which reduces output further. Low growth also tends to prompt businesses to cut investment, which further hits economic activity. In this scenario, the economy has “stalled” because the slow rate of economic expansion was not fast enough to keep the economic engine going.
Economists’ estimates of the stall-speed threshold are based on looking at countries’ historical patterns of growth and decline.
The growing belief in the existence of stall speed could change the complex calculus used by sovereign bond investors to judge the attractiveness of a country’s sovereign market, because it suggests that governments trying to shore up their bond markets by closing budget deficits must walk an even narrower tightrope than previously assumed.
Governments have tended, in the past, to follow the rule of thumb that while an excessively generous fiscal policy will prevent them from cutting the deficit, they should also avoid a regime tight enough to push the economy into recession — because recessions cause large falls in tax revenue. However, the stall-speed concept suggests that even if fiscal tightening results only in a modest reduction of growth to slightly below normal, this could eventually generate outright recession and unmanageable falls in tax income, as low output begets even lower output.
Looking at recent hard economic data for evidence of stall speed, the OECD report notes that “as growth has eased,” the “the gradual reduction in unemployment” in Germany has come to an end — a classic stall speed symptom. It adds, however, that despite lower-than-normal growth, “unemployment has continued to drift down in the United States,” while expressing concern that “unemployment could rise quickly” if growth weakened.
The organization predicted overall growth of 1.4 percent for its 34 member states as a whole — a figure depressed by its forecast of a slight fall in euro zone output for the second straight year. “The global economy is expected to make a hesitant and uneven recovery over the coming two years,” it warned.
