A global economic slowdown is under way, and it doesn't look like anything the world has recently seen. New structural forces are shaping the slide--forces that monetary policymakers in the U.S., Japan, and Germany should be extremely sensitive to in the months ahead.
There is no reason yet to believe recession is on the way. But policymakers around the world should admit that 1995 is not turning out as well as expected. Rates of growth are dropping everywhere. The second quarter in the U.S. is coming in feebler than anticipated. Around the Pacific Rim, from Singapore to China, economies are throttling back. Japan is teetering on recession. Mexico is still in shock. And much of Latin America is in recession. German manufacturers are hitting a brick wall. And Europe's expansion is stalling out. These disappointments may be symptoms of a deflation in the global economy that policymakers are missing.
This unusual synchronous slowdown suggests that forces beyond the normal economic cycle are at work. Japan, for example, is in its fifth year of a deflationary dive. A bureaucratic elite has been running a tight-money, mercantilist policy--resulting in low growth, an overvalued yen, a looming banking crisis, rising unemployment, and a hollowing-out of manufacturing. Meanwhile, a weak and divided political system offers no guidance.
Similar problems plague Germany and the rest of Europe. A soaring mark and the highest labor costs in the industrialized world are prompting German companies to engage in an investment boycott of their own country.
Powerful new forces are at work in the U.S. as well. A balanced-budget agreement will probably emerge and be signed by the fall. Desirable as this may be in the long run-- boosting savings and investment--the short-run impact is deflationary. Today, one out of six working Americans has a government job. That may fall sharply in the years ahead. Just as defense cutbacks proved unexpectedly harsh, so will the transition to smaller government.
None of this argues for canceling the forecast of a comeback in the fourth quarter for the U.S. economy and beyond. There are countervailing forces that can more than offset the negatives on the horizon. The galloping inflation of the '70s and '80s appears truly dead, thanks to global competition, low-unit labor costs, and high real interest rates. Productivity has jumped to a higher level thanks to new technology. Corporations are investing heavily in capital equipment and new capacity. Indeed, recent records in the stock market clearly imply that investors are confident that corporate profits can stay high.
But the current slowdown, particularly because it was unexpected, highlights the existence of deflationary economic reefs that can sink the global economy. In a world of growing deflation, running the proper monetary policy becomes more important than ever. The message is clear. Up to this point, the Federal Reserve, the Bank of Japan, and the German Central Bank have erred on the side of restraint. In the months ahead, all three central banks should consider erring on the side of ease.