The US is on the verge of a recession.The latest economic data released by its department of commerce on Wednesday is worse than expected. The world’s largest economy inched ahead at an annual rate of 0.6% from October to December. That’s a sharp slowdown from the fast-clip 4.9% growth clocked in the previous quarter. It’s not hard to guess what the epicentre of trouble is. Building activity collapsed to its worst performance in 25 years—and there are likely more housing-market tremors ahead.
This comes just a few days after the International Monetary Fund (IMF) put out its own bleak prognosis for the US economy. IMF chief Dominique Strauss-Kahn said at the Davos gabfest that he expected a “serious slowdown” in US growth. But the actual numbers could have surprised him as well. IMF has cut its forecast for global growth in 2008 from 4.4% to 4.1%, largely because it expects the US to grow at a tortoise-trot 1.5% this year. That estimate now seems overly optimistic.
The months ahead will provide real tests for the decoupling thesis—the beguiling idea that Asia can grow unhindered despite a sharp US slowdown or recession. It is highly unlikely that growth in this part of the world will be unaffected by what is happening in the US. India’s own gross domestic product?growth could take a 0.5% cut in 2008.
Given all this, it is not surprising that US Federal Reserve chairman Ben Bernanke cut the target federal funds rate by another 50 basis points on Wednesday, taking the total cut this month to 125 basis points. At 3%, the federal funds rate is below the US consumer inflation rate. That means real short-term interest rates in the US are negative.
The question is whether such a loose monetary policy will quickly revive US growth. It is unlikely. Bubbles usually burst with painful?after-effects. And Bernanke’s ability to keep cutting interest rates is limited by the fact that the US is also facing inflationary pressures. The Fed says that while US inflation will drop in the coming months, it will have to carefully monitor price levels.
The Wednesday data release bears this out. Inflation has inched up, even if volatile items such as food and fuel are not considered.
A simultaneous drop in growth and rise in inflation can be a policy nightmare. The US stagflation will be bad news for the rest of the world as well.
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