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The Struggling Economic Recovery

Author: Roya Wolverson
August 18, 2010

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Gloomy economic indicators continue to raise questions about the sturdiness of the global economic recovery. Weak global demand for American exports, a near 10 percent U.S. unemployment rate, and sluggish bank lending (Bloomberg) have led to doubts about the Obama administration's efforts to stimulate the economy with a new jobs bill (WSJ). Questions also loom about the Federal Reserve's decision to keep interest rates low indefinitely and how long markets will tolerate high U.S. debt.

A major concern internationally is whether growth in China, India, and Japan can continue to offset sluggish recoveries in the United States and Europe. The Federal Reserve warned last week that the pace of the U.S. recovery had slowed, while weaker retail sales and imports last month in China suggest its economy is beginning to cool (NYT). Japan's sharp drop in economic growth in the second quarter is also fueling doubts about its fragile recovery, given its rising public debt and persistent deflation (WSJ).

In the Financial Times, the Peterson Institute's Arvind Subramanian says despite its recent economic success, India is not likely to achieve "Chinese-type growth rates," because of the country's endemic corruption and bloated public sector. News that China would likely overtake Japan as the world's second largest economy this year was tempered by reminders that China (FT) still ranks just 103rd globally in terms of per capita GDP, according to the World Bank, and more than 150 million Chinese live on less $1 dollar per day. Critics also point to China's undervalued currency and reliance on export-led growth (NYT), which could hamper the global recovery if demand from debt-riddled U.S. consumers weakens.

Still, U.S. consumer demand (Bloomberg) for Chinese exports is recovering, despite high unemployment. Peter Morici, former chief economist at the U.S. International Trade Commission, says this trend is causing deflation (UPI), because "each additional dollar spent on imports that doesn't return to purchase U.S. exports reduces demand for what Americans make."

How the Fed would combat deflation is unclear, given that short-term interest rates are already near zero. The central bank's announcement last week (Reuters) that it would invest the proceeds of maturing securities into long-term Treasuries disappointed some investors, who had hoped for more so-called "quantitative easing" (increasing the money supply by buying government or other securities) to further loosen monetary policy.

Joseph Gagnon of the Peterson Institute argues (Economist) the Fed still has room to lower the interest rate paid on bank reserves and the rates on longer-term Treasury securities, which he says would pose "essentially no risk to the Fed's balance sheet." In a Financial Times op-ed, Citi Private Bank's Richard Cookson says (FT) the Fed is being criticized both for risking inflation if monetary stimulus goes too far and for being too timid in responding to slowing growth. The Fed may fail to achieve its dual mandate of maximizing employment and stabilizing prices, he admits. But when a country is suffering from "debt addiction" all the Fed can do is "manage the worst symptoms of withdrawal."

Additional Analysis:

On the blog VOX, economists Carmen Reinhart and Kenneth Rogoff examine the link between debt, growth, and inflation, amid calls from some economists for more or less fiscal stimulus for the wealthiest economies.

Assessing the Fed's latest decision to use proceeds from its mortgage-bond portfolio to buy long-term Treasury securities, the New York Times says the Fed's options now are more limited than they were three years ago, and the consequences of its actions potentially more dangerous.

Background:

Read the full text of the Fed's August 10 Open Market Committee statement here.

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