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UCSD roundtable speaker blames disappointing recovery on deleveraging

The global economy is growing on average, but it’s seeing a disappointing recovery from a “synchronized, severe” recession, said Richard Clarida at a University of California, San Diego economics roundtable on Thursday.

“The slowdown is broad based across regions and parts of the world,” said Clarida, who is the C. Lowell Harriss Professor of Economics at Columbia University and a global strategic adviser at PIMCO. “Europe is in a recession. The U.K. is in a recession, the U.S. has 2 percent growth … China is at 7 percent growth. We think it’s great, but in China it feels like 2 percent.”

The recovery has been disappointing partly because of deleveraging, Clarida said, which has been required because of the amount of leverage in the global system. He referred to the time of “Great Moderation” when there was growth, low volatility, low inflation and “great leveraging” of balance sheets.

Deleveraging in households has proven to be a headwind to economic activity, Clarida said. High borrowing costs in the eurozone is also a headwind to economic activity, as is fiscal consolidation, according to Clarida.

“Government debt relative to GDP is still growing in some countries. [Some countries] are tightening fiscal balances but still growing debt,” he said.

In early 2010, Clarida said all markets in Europe traded together.

“An eye-popping fact is that as early as 2006, Greece was borrowing 10-year money at five basis points per year,” Clarida said. “Italy and Spain would look much different if they could borrow at German interest rates.”

He said the cumulative growth from 2000 to 2010 in Italy was 1 percent, where there has been a “large stock of debt” for a long time. In Spain, there has been a housing boom and bust, and Clarida said banks are underwater.

The central banks’ response has been turning up the printing press and making more money, according to Clarida. Going into the crisis, the Fed’s balance sheet was about $800 billion and almost exclusively in Treasury securities maturing in three years. Now, Clarida said it’s up to $2.7 trillion and in Treasury maturities out to 30 years.

“The central banks, through words and deed, pushed further and further out the day markets will increase interest rates,” which will depress interest rates today, Clarida said.

Europe’s problem, according to Clarida, is that going into the crisis, the big banking system was dependent on wholesale funding and encouraged to buy sovereign debt, now causing an “adverse feedback loop.”

Clarida follows the “flow of data surprises,” where the European Central Bank and euro expectations were higher or lower than expected.

“On average, they do zero out — people aren’t surprised,” Clarida said. The challenge in Europe is that different scenarios can play out, and there’s “no playbook.”

“Were there to be a meltdown in Europe … it would not be contained to Europe,” Clarida said. He defined a meltdown as a significant recession with -3 percent gross domestic product. “We’re all in this together. If Europe goes down, it will impact global trade.”

Oil prices are another risk to the global outlook, and a risk of supply disruption for oil could cause a global recession, Clarida said.

This past year in the United States, forecasters and the Fed marked down the outlook for U.S. growth. Clarida said in March 2010, 3.4 percent growth was predicted for this year and now is at 2 percent.

A cause for this is deleveraging, and “no one knows when it will come to an end,” Clarida said. “In order to deleverage, households are saving more, as opposed to relying on appreciation from homes.”

Housing “leads the economy” out of a recovery, but the level of housing starts has been “at a depressed level for some time,” he said.

The level of unemployment is also still “very elevated” compared to any previous cycle.

The Federal Reserve Bank has said interest rates will remain at current levels until 2014. Clarida said the first time the Fed used a calendar date was in August 2011, but it is not a calendar date commitment. If the economic conditions change, the date can change, he said. The Fed will rely on forward guidance in its June meetings and into the fall, Clarida said.

“The Fed is very sensitive to expectations of inflation,” he said.

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