Fitch has put France on rating outlook negative and a host of other Euro sovereigns on a ratings negative watch. Ontario was also placed on ratings outlook negative yesterday by Moody’s.
Our bear case: full-blown global recession: To model such a global bear case, we assume that, contrary to our base case assumptions, US Congress fails to extend the payroll tax cut and the extended unemployment benefits into 2012, which would result in a fiscal tightening of a little more than 1% of GDP. In Europe, our bear case assumes governments do not come up with a convincing fiscal solution on December 9 and bond yields in response push higher still. These policy mistakes depress confidence and domestic demand further. Transmission to the rest of the world follows through the asset price channel, through further bank deleveraging, and the trade channel – we assume a halving of world trade growth compared to the baseline. As a consequence, global growth plunges to 1.9% in 2012 and thus below the recession threshold of 2.5%. The US economy contracts for most of 2012, Europe through all of the year. China’s GDP growth slows to 7.7%, with rapid fiscal easing preventing a worse outcome.
Super-bear case: you don’t really want to know: So, depending on the policy decision taken or not taken over the next month, our bear case for the global economy may soon become the base case.
In fact, even our bear case may still be too optimistic. If European governments fail to agree on a big step towards fiscal integration on December 9, and if the ECB refuses to step up support, a super-bear scenario including serial private and public sector defaults and euro break-up may well materialise.
To be sure, we still view this as a tail event, even though the tail has become fatter recently. Putting numbers for GDP and other economic indicators to such a scenario is extremely difficult. Yet, the Great Recession that followed the Lehman bankruptcy would probably pale in comparison to a scenario involving a euro break-up and widespread bank and government failures.
the system is weaker than we thought. The politicians and regulators look for independent analysis from academia to drive us forward, however that analysis may well be severely conflicted. To get rich quick, the academics, central bankers and regulators have an interest to keep filling the punchbowl, as they too are drinking from it.
The supposed benefit of appointing professors to run central banks is the concept that we are getting independent, intelligent individuals who have the ‘general good’ as their goal – a type of benevolent dictator. Maybe, however, part of their rise through academia came through the money that Wall Street threw at themselves, their departments and their universities.
The thing that amused me most in the interviews with these potentially conflicted economists was that they had trouble understanding where the conflict of interest lay (1hr 22mins). If any profession should know how incentives work then surely it is the economists.
If the intellectual and political establishments are too beholden to the system they are meant to control then we have yet another new problem to add to the list. What else will we learn next year?