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Sunday, November 02, 2008 6:01 PM

Global ZIRP And The "Impossible Contraction"

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The global race to ZIRP is on. Let's recap the state of affairs of the mad march to zero interest rates.

Bank of Japan Cuts Rate to 0.3%

In an attempt to fend off a prolonged recession, the Bank of Japan Cuts Rate to 0.3%.

The Bank of Japan cut its benchmark interest rate to 0.3 percent to help stave off a prolonged recession. Governor Masaaki Shirakawa cast the deciding vote to lower the key overnight lending rate from 0.5 percent after four of the eight board members dissented, the central bank said in Tokyo today. Three wanted to cut the rate to 0.25 percent, and one voted to leave it unchanged, Shirakawa said.

Cheaper credit may provide some relief to Prime Minister Taro Aso, who yesterday unveiled a $51 billion economic stimulus package in a bid to minimize the effect of tumbling stock prices and the surging yen on the economy.
Fed Cuts Rate To 1%

At the October FOMC meeting the Fed cut rates to 1% and signaled willingness to cut at the next meeting in December. There is currently a 70% chance of some cut in December with another 50 basis point cut at 40% probability. See ZIRP Coming To Fed? for more details.

Unexpected Cuts In India

Bloomberg is reporting India Unexpectedly Cut Interest Rates to Spur Growth.
India's central bank unexpectedly cut interest rates for the second time in two weeks and reduced the amount of money lenders must hold in reserve in a bid to protect the economy from the global slowdown.

The Reserve Bank of India lowered its repurchase rate to 7.5 percent from 8 percent, reduced the amount of deposits that lenders need to set aside as reserves to 5.5 percent from 6.5 percent, and cut the amount of money lenders are required to keep in government bonds to 24 percent from 25 percent.

The steps signal a U-turn from the Reserve Bank's policy stance just a week ago, when Governor Duvvuri Subbarao said a "heightened vigil" was needed to fight inflation.
ECB To Follow

The ECB is expected to follow suit as Fed, BOJ, India 'Shocked' Into Cuts.
The Bank of Japan yesterday cut its benchmark rate for the first time in seven years and China pared its key rate for a third time in two months. Central banks in Norway, Slovakia, South Korea, Taiwan, Israel and across the Middle East also eased credit.

Policy makers are fighting to avert a prolonged recession in the global economy as the credit crisis enters its 15th month and spreads beyond industrial countries. Officials are signaling more cuts are likely and the European Central Bank and Bank of England both set policy on Nov. 6.

"This was the week central banks got shocked into action," said Stuart Thomson, who helps oversee $46 billion in bonds at Resolution Investment Management Ltd. in Glasgow, Scotland.

Fed Chairman Ben S. Bernanke and his colleagues are also signaling they may cut their benchmark rate further after lowering it to 1 percent as "downside risks to growth remain." The economy contracted by the most since 2001 in the third quarter and Fed Bank of San Francisco President Janet Yellen said on Oct. 30 that rates may head to zero if economic pain persists.

Oil-producing nations are also resorting to lower rates after the price of crude dropped by half from a July record of $147.27 per barrel. Norway's central bank cut its benchmark by a half-percentage point for the second time last month. Saudi Arabia, Kuwait and Bahrain, which tend to shift their interest rates in line with the U.S. to maintain currency pegs to the dollar, also followed the Fed in cutting.

Not all central banks are easing. Iceland this week unexpectedly raised its main rate to 18 percent, the highest in at least seven years, as it battles a currency crisis and possible hyperinflation with the help of the International Monetary Fund.

Economists forecast that the onset of a recession in Europe will force the ECB and the Bank of England to lower their benchmark rates on Nov. 6 by a half-point to 3.25 percent and 4 percent respectively.

Both will cut to 2.5 percent by the middle of next year, according to median forecasts in two surveys. That would be the fastest pace of easing in the ECB's history.

Australia's central bank may also cut rates on Nov. 4, after lowering them by 1 percentage point to 6 percent last month, the biggest reduction since 1992.

At JPMorgan Chase & Co., economists are predicting their global interest rate measure will fall to 2.16 percent next year, the lowest since it was first devised in the mid 1990s, from 3.21 percent yesterday. They estimate the global economy will contract in the current and subsequent quarters.
Global Recession Is Here

The IMF definition of a global recession is a dip below 3% growth. I am comfortable we are in that scenario already. An outright contraction is just around the corner.

Parsing The Global Recession

Flashback April 11 2008

Portfolio.Com is Parsing the Global Recession.
We all know what a recession is: two consecutive quarters of negative growth. Easy. So a global recession, that's the same thing, but on a global level, right? Actually, no. Recessions happen, in all countries, but they don't happen in all countries simultaneously, and it's pretty much impossible for the entire world to register negative growth in any given quarter.

So don't be too alarmed when the likes of Andrew Leonard say things like this (italics his): Today, the International Monetary Fund conceded that there is now a 1-in-4 chance of a global recession occurring in the next 12 months. [See IMF says US crisis is 'largest financial shock since Great Depression']

The problem here is that he's not defining his terms. And if you look at the actual document IMF Predicts Slower World Growth Amid Serious Market Crisis , you'll see that the IMF's definition of a "global recession" is global growth of 3% or less. Which suddenly seems much less scary.
What Is A Recession?

The widely used definition of a recession is "Two consecutive quarters of negative growth". However, that definition is wrong. Contraction for two quarters is indeed a sufficient condition, however it is not a necessary condition.

The Business Cycle Dating Committee, National Bureau of Economic Research describes the Recession Dating Procedure.
A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. Between trough and peak, the economy is in an expansion. Expansion is the normal state of the economy; most recessions are brief and they have been rare in recent decades.
Recession FAQs

Further clarification of process is found in the NBER’s Recession Dating Procedure FAQs
Q: The financial press often states the definition of a recession as two consecutive quarters of decline in real GDP. How does that relate to the NBER's recession dating procedure?

A: Most of the recessions identified by our procedures do consist of two or more quarters of declining real GDP, but not all of them. The most recent recession in our chronology was in 2001. According to data as of July 2008, the 2001 recession involved declines in the first and third quarters of 2001 but not in two consecutive quarters. Our procedure differs from the two-quarter rule in a number of ways. First, we consider the depth as well as the duration of the decline in economic activity. Recall that our definition includes the phrase, "a significant decline in economic activity." Second, we use a broader array of indicators than just real GDP. One reason for this is that the GDP data are subject to considerable revision. Third, we use monthly indicators to arrive at a monthly chronology. ....
The Impossible Is About To Happen

Felix Salmon writes "Recessions happen, in all countries, but they don't happen in all countries simultaneously, and it's pretty much impossible for the entire world to register negative growth in any given quarter."

Indeed, not every country will contract in this global recession. China will be a notable exception, assuming one believes Chinese GDP reports. However, even China is suffering a steep manufacturing recession as noted in Tail Wags Dog Theory Blows Up.

China aside, I believe enough countries will contract to cause the afore mentioned impossible global contraction to happen.

Mike "Mish" Shedlock
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