Has Global Stag-Deflation Arrived?

Policymakers must now worry about a strange beast called “stag-deflation” (a combination of economic stagnation/recession and deflation). That means they also have to worry about about liquidity traps (when montary policy becomes ineffective) and debt deflation (when the rising real value of nominal debts threatens households, firms, financial institutions, and governments).

NEW YORK – The latest macroeconomic news from the United States, other advanced economies, and emerging markets confirms that the global economy will face a severe recession in 2009. In the US, recession started in December 2007, and will last at least until December 2009 – the longest and deepest US recession since World War II, with the cumulative fall in GDP possibly exceeding 5%.

The recession in other advanced economies (the euro zone, United Kingdom, European Union, Canada, Japan, Australia, and New Zealand) started in the second quarter of 2008, before the financial turmoil in September and October further aggravated the global credit crunch. This contraction has become even more severe since then.

There is now also the beginning of a hard landing in emerging markets as the recession in advanced economies, falling commodity prices, and capital flight take their toll on growth. Indeed, the world should expect a near recession in Russia and Brazil in 2009, owing to low commodity prices, and a sharp slowdown in China and India that will be the equivalent of a hard landing (growth well below potential) for these countries.

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