An economic recovery is regarded to be healthy if it is not clear what will cause the next recession.

By definition, a recession is a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters.

Although it has been disappointingly slow at times, the recovery from the 2008 financial crisis has been regarded to be relatively healthy over the past decade. This is now being threatened by several forces combining together to create the current situation of uncertainty, which was subsequently translated into financial markets.

Investors demanding higher yields for short-term US bonds than for those with longer maturities, widening credit swaps and a decline in commodity prices have all contributed towards additional turmoil within financial markets.

In comparison to equity markets, yield curve inversions have historically provided accurate recession predictions. The overall current judgement of financial markets relates to the fact that the re-occurrence of a recession is more likely than not in the next two years.

Real economic indicators relating to the world’s largest economies, mainly referring to the US and China, have also demonstrated additional causes for concern. For instance, China’s Shanghai composite index lost more than a quarter of its value in 2018, as trade tensions between China and the US persisted.

The inflation rate in the US has recently been running below the Federal Reserve’s 2 per cent target. Business and consumer sentiment forward looking indicators suggest that growth is likely to decline. Given the high levels of debt and low unemployment levels, a recession is more likely to occur.

In the face of serious economic problems in both China and the US, apart from their conflicts over trade and technology, it is difficult to believe that the global economy will remain healthy. Likewise, Europe is also hit with market turbulence and political uncertainties. Problems associated with Brexit, French protests, the German political transition and Italy’s current situation imply that in such circumstances, the European continent is more likely to be a source of problems rather than a solution.

Taking into consideration the current geographical uncertainty, high debt levels in various countries, together with other factors which are leading towards a rise in private spending and reduced private investment, the main challenge for monetary and fiscal policy will be to maintain sufficient demand.

The best way for central banks to contribute towards financial stability in such a situation is to ensure that they recognise that avoiding another recession is the most important thing they can contribute in relation to global economic progress. The Fed should signal that it is determined to avoid a downturn that would assure another decade of below target inflation.

Fiscal policymakers should understand that the low real yield on government bonds may serve as a clear indication that additional debt can be absorbed. Moreover, the largest economies should also try limiting any trade frictions and signal towards commitment to support global growth by assuring capital flows to emerging markets. A shift towards emphasising growth may diminish the fears of a reoccurring recession.

Disclaimer:

This article was issued by Andrew Fenech, research analyst at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.