As I look back over the past year, I tend to see a stumbling asset market (in this case the asset being residential housing), a contractionary energy-price shock (at least through summer), and relatively tight monetary policy (as evidenced by the inverted Treasury yield curve). I might normally associate such a confluence with a tipping point in economic activity (in the wrong direction), but it increasingly looks like it isn't going to happen.
Perhaps, as suggested in today's Wall Street Journal (page A1 in the print edition), the hero of the story is the recent reversal of the earlier oil and energy shocks:
Oil prices fell sharply yesterday and are now hovering at their lowest levels since mid-2005, raising the prospect of significant changes in the outlook for corporate profits, consumer spending and the global economy.
... oil's pullback "is coming at a great moment for the U.S. economy," says Ethan Harris, chief U.S. economist at Lehman Brothers in New York, who estimates that each $10 reduction in oil prices adds about a half percentage point to annualized growth in inflation-adjusted gross domestic product -- a broad measure of economic activity.
"You're worried about this one-two punch from housing -- first construction collapses, and then the consumer collapses. Lower energy prices are acting as a sort of smelling salt," Mr. Harris said.
I'm sympathetic to that view, but I also have to believe that part of the story is that the underlying "fundamentals" in both the US and global economy are incredibly strong. What are those fundamentals? I think Martin Wold nailed it:
Evidently, the underlying engine of the world economy is immensely powerful. So, indeed, it is. Today’s world economy is being driven by four closely interconnected forces: technological innovation, above all the collapse in the cost of collecting, analysing and transmitting information; entry into the world economy of the vast majority of human beings and, above all, of the half of humanity that lives in east and south Asia; the “catch-up” process in these economies; and the integration of global markets in goods, services and capital that we call globalisation...
To these forces should be added the background condition of monetary stability. We seem to know how to make a world of man-made (as opposed to commodity-based) money stable. This then has delivered low nominal interest rates. Combined with strong profits, rapid growth across the world and improved fiscal and trade positions in emerging market economies, spreads on risky assets have fallen to low levels...
The implication of this perspective is that any slowdown – or “mid-cycle correction” – will be short-term and shallow...
Provided the broad story of economic dynamism remains credible, the world economy will probably overcome temporary difficulties, including any needed adjustment of external imbalances or volatility in oil prices. But if the credibility of that broad story came into question, then such optimism must vanish.
So how plausible is maintenance of the underlying dynamic? For economic policy, this raises two big questions: the first is whether inflation will be contained; the second is whether globalisation will be sustained. On the former, there is no reason to forget what we have so painfully learned. On the latter, however, there is greater uncertainty.
On the latter, those lessons have an even longer and more painful history -- here and here, for example. If we don't forget them, we'll be just fine. If we do...