View From Down Under

2009 was clearly the year of stimulus.  Governments around the world responded to the financial crisis with very strong fiscal and monetary stimulus programs.  The year also validated stimulus as an effective method of helping economies out of a recession.  This was true in Australia, China, much of Europe, and even the US (although the US stimulus was relatively light and the impact less pronounced).

All of the world’s economies are likely now out of technical recession – with the possible exception of Iceland and one or two others.  However, that does not mean the world’s economies are out of danger.  The possibility of slipping back into negative GDP territory is still real – as was demonstrated when Singapore shrank 6.8% in the fourth quarter vs growth of 14.9% in the third.

The big challenge for 2010 will be how to unwind the stimulus programs without pushing the economy back into recession.  Nobel prize winning economist (and self confessed liberal) Paul Krugman believes the likelihood that the US gets this wrong is “better than even”.  Other economists are also concerned that low underlying growth and withdrawal of stimulus will cause a double dip recession.

There are some lessons from other countries’ efforts to unwind their stimulus.  Australia, which had the mildest recession of any OECD country, has already raised interest rates three times and their fiscal stimulus programs are largely finished.  Stimulus programs included reducing interest rates (by 4% from September 08 to February 09) and cash handouts to low and middle income families in October and December 2008.  Reducing interest rates has a bigger impact in Australia than the US because about 80% of Australian households have variable rate mortgages.  As you can see below, the impact on retail sales was pronounced, spiking as the cash payments were received.  However, since April and the withdrawal of stimulus, retail sales have been slightly negative overall.  (Fortunately, Australian GDP does not depend entirely on retail sales, but it is a major component.)

Clearly the removal of all stimulus for the US economy now would cause the economy to slip back into recession.  That won’t happen, but there is a likelihood that without further stimulus the economy will still falter.  Personally I am more bullish about the odds than Mr Krugman, but the Fed and Congress need to manage the process carefully and some further fiscal stimulus may well be appropriate.

With a bit of luck, the year of stimulus will be followed by year of the gradual unwind.