The U.S. plan to bail out collapsing financial institutions may help stabilize markets but won't necessarily stave off the economic effects of the crisis, some economists warn.
“So far, so good. However, we remain cautious on the outlook for the U.S. and U.K. economy,” said Julian Jessop, chief international economist at London-based Capital Economics. “The economic backdrop remains weak.”
The plan will likely help settle turbulence in markets, but the financial sector is still in “critical condition,” he added.
Lower oil prices are helping the outlook for inflation and giving central banks more flexibility to lower interest rates, he said, but a strong recovery probably won't be evident until 2010.
“In the meantime, the financial and economic imbalances have taken years to build up and may well take years to unwind.”
Investors have been driving down markets as they shy away from risk, but also because they fear a global recession, noted economists at Bank of Nova Scotia.
Washington's plan addresses the financial firms issue, but not the global recession problem.
“Clearing up much of the junk on the markets would still leave the lagged effects in front by way of the economic fall-out,” they wrote in their morning commentary. “That may mean that the immediate reaction based upon speculation is overblown, since we fail to see how depressed earnings in a downturn would be good for equities.”
But economists at Goldman Sachs said today's financial crisis is so unprecedented that it's difficult to know how bad the lagged economic effects will be.
“While the latest bout of financial market stress is likely to pose some downside risk to growth estimates, it is also important not to be too hasty in expecting a major economic crisis,” said Goldman economists Binit Patel and Dominic Wilson.
“In these difficult market times, it can be valuable to look at the past for clues about the future. Unfortunately, the scale of today's credit and financial crisis do not present comparable historical templates.”
The Asian financial crisis in 1998 did not have a long-lasting impact on world growth, they note. And the 1987 market crash did not stall the global economy for long, since the U.S. Federal Reserve took decisive action to stem the rot.
“If we fast forward to today, it is clear that the risks facing the U.S. economy (and elsewhere) are greater than they were in 1987,” the Goldman economists said. “But...policy responses have also been much greater than in 1987.”
The Fed rate cuts and liquidity measures are now accompanied by lower oil prices and easing inflationary pressure, giving central banks room to cut further and stimulate spending to support the economy. Plus, the U.S. trade sector should improve rapidly in the next few months, also boosting economic growth.
“The bottom line is that the world economy does face a number of challenges in the months to come, as do central bankers and policy makers. But policy makers are clearly proving themselves to be up to the task – something that should help to limit the downside risks to the world economy.”
Economists at High Frequency Economics were not so optimistic.
“The rescue of the banking system is a necessary ingredient for global economic prosperity, but it is insufficient to ensure it on its own,” writes chief economist Carl Weinberg.
“Fixing the banks does not fix the economy. Even with the banking problems fixed, the United States economy remains in a growth recession, teetering on the brink of real contraction.”
He argues that massive public-sector borrowing in the United States is already crowding out private sector investment, and the huge debt needed to back the new rescue plan will exacerbate that situation.
The U.S. slump will ensure sluggish growth in Canada as well, he adds. And the bailout plan is not going to do anything to prevent looming recessions in Europe and Japan.
Global growth is being hobbled by flat or falling real wages, depressed exports, public sector inaction in the face of recession, and in Europe at least, interest rates that are too high.
He predicts central-bank rate cutting all around, with the European Central Bank moving before the end of the year, the Bank of England moving early next year, and the Bank of Canada moving in October.
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