Monday, 3 September 2007

Japanese and US economies face downturn

"Normalisation" of interest rates in Japan appear to be moving further and further away.

Following a report last week that Japan's manufacturing PMI edged up to 49.6 in August but remained below 50 for the second month in a row, we have another report today that indicates that the Japanese economy could be in a bit of trouble. From FT:

Japanese companies have cut capital spending for the first time in four years, threatening to push the country’s economic growth into negative territory for the first time in 10 quarters.

Capex, one of the strong points of Japan’s rather patchy economic recovery in recent years, sank 4.9 per cent from a year earlier in the second quarter, according to official figures published on Monday.

That will make it extremely difficult for the Bank of Japan to raise its benchmark interest rate – currently 0.5 per cent - at its next meeting September 19.

The poor capex figures, caused by a sharp fall in spending in the predominantly domestically focused non-manufacturing sector, were accompanied by poor numbers on employees’ earnings, including the biggest drop in total cash payments in more than three years.

Meanwhile, the pessimistic outlook on the US economy wasn't dispelled at Jackson Hole despite the Fed chairman's speech on Friday, if this Bloomberg story is anything to go by:

"I came to Jackson Hole thinking there would be no recession, but I'm leaving thinking we could well have one,'' said Susan Wachter, a professor at the University of Pennsylvania's Wharton School, who co-wrote the first academic paper presented at the conference.

This year's theme...was housing and monetary policy, eliciting forecasts of sliding home prices and criticism the Fed should have done more. Martin Feldstein of Harvard University warned of a "very serious downturn" and called on policy makers to cut interest rates by 1 percentage point...

"There are no optimists in the crowd here," said Ethan Harris, chief U.S. economist at Lehman Brothers Holdings Inc. in New York and a former head of domestic research at the New York Fed. "There's a pretty strong consensus that this has gotten a lot more serious."

There was also criticism of the Fed.

... Edward Leamer, the head of an economic forecasting group at the University of California at Los Angeles...wrote in one of the conference papers that the Fed merited an 'F' for failing to prevent the housing bubble and then not reducing rates as it burst.

How could the Fed have avoided the bubble and its bursting? John Taylor has a suggestion, reported by Reuters:

"A higher federal funds path would have avoided much of the housing boom," said John Taylor, former U.S. undersecretary for international affairs, drawing on a model he designed to simulate housing activity if the Fed had raised rates instead of aggressively easing borrowing costs.

"The analysis also suggests that the reversal of the boom and thereby the resulting market turmoil would not have been as sharp," he said.

At the moment, though, lower global interest rates look like what we are about to get as the Fed contemplates rate cuts and the BoJ and ECB delay rate hikes.

Update: There is more on Leamer's paper at Calculated Risk while James Hamilton at Econbrowser provides some details of Taylor's analysis.

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