The words appear with more frequency in news articles; they crackle across the airwaves on television and radio: Asian crisis, recession, deflation. We talked to Kent State University economics professor Michael Ellis, to find out what it all means. Ellis, who received his doctorate from Texas A&M University, focuses his teaching and research on international monetary economics and macroeconomics. He is a policy analyst for the Buckeye Institute for Public Policy Solutions. His research has appeared in many academic journals including the Journal of Macroeconomics, the Journal of International Money and Finance and the Journal of Monetary Economics.
Talk of a coming recession is becoming more prevalent with the recent downturns on Wall Street. Do you see any emphatic indicators of a recession?
I see signs of an economic slowdown, but not necessarily a recession. Over the last year, the growth of the trade deficit resulting from the Asian crisis has been a drag on growth, but so far consumption spending by households and investment spending by business has been strong enough to keep the economy growing.
The big question is whether this will continue to be the case. One reason for strong consumption spending has been the increased wealth caused by stock price inflation. If the recent deflation in stock prices continues, it may weaken consumption spending. This in turn would weaken business spending. It is difficult to be confident in predictions of how consumption spending would respond to stock price deflation, since the large increase in stock holdings by households is a relatively recent phenomenon.
Historically, stock prices have not been a good predictor of consumption spending. Another factor concerns the direction of monetary policy. Past experience suggests the Federal Reserve will follow the recent decrease in interest rates with further rate cuts. On the basis of these factors, I believe that the U.S. economy will be able to avoid recession over the next year, but growth will be slower than in the past year.
You mentioned the Asian crisis. How can the situation in Japan affect the global economy?
The Asian crisis is really the biggest threat to the global economy.
First, Japan is the second largest economy in the world, so the Japanese recession has a significant direct effect. It should be emphasized that this is not a temporary downturn-it is a structural problem in the banking system.
Lending institutions in Japan did not allocate credit in an efficient way, so there has been widespread default by debtors. It is difficult to measure the extent of the problem since close links between companies have made it easy for firms to hide debt by shifting it to another company’s balance sheet.
The conventional wisdom is that the Japanese problem is far larger than the S&L crisis in the United States. The great danger is that Japanese banks will not extend credit to business for a prolonged period of time. In this situation, something similar to the U.S. experience of the 1930s is possible in Japan.
The global effects of the Japanese situation are multiplied because without a strong Japan, the entire Asian region will have difficulty recovering from the crisis. Further, the Asian crisis has led to a pull-back by investors in emerging markets outside of Asia.
In an effort to keep funds from leaving, the central banks in these emerging markets have increased interest rates which has in turn weakened their economies. We are seeing this is Latin America, for example. With the crisis spreading to economics beyond Asia, it is clear that world economic growth will be significantly reduced over the next year.
We’ve discussed the economy over the near term. What are some factors to consider when looking at economic growth over the long term?
Technology is a major factor for the long term performance of the U.S. economy. Technology is anything that determines how much output can be produced from resources such as labor and capital.
Historically, it has been the case that technological changes do not have a large immediate impact on economic performance; it usually impacts the economy with a lag. For example, the post World War II boom in the United States was based on mass manufacturing techniques developed early in the century, so there was a lag of several decades.
In the last few decades, technological advances in areas such as computer technology have begun to change the economy, but the largest effects may not have been seen yet. This implies an optimistic view of the long term growth prospects of the U.S. economy.
Another development has been the reintegration of a large part of the world’s population into the world economy after the fall of communism and the embracing of market oriented economic policies around the world. As the current situation reminds us, this process will not be without problems, but over the long term these export markets will be a growth area for U.S. businesses.