Four scenarios for the global economic downturn

That we have entered a UK recession is a certainty, but that doesn’t make it easy to plan for because there remains a great deal of uncertainty about the shape that the downturn will take, as explored in this article in the McKinsey Quarterly (free registration required).

Uncertainty surrounds not only the downturn’s depth and duration—though these are decidedly big unknowns—but also the very future of a global economic order until recently characterized by free-flowing capital and trade and by ever-deepening economic ties. A few months ago, the only challenges to this global system seemed to be external ones like climate change, terrorism, and war. Now, every day brings news that makes all of us wonder if the system itself will survive.

The authors of the article have therefore sketched out four scenarios to capture the wide range of possible outcomes. The scenarios are based on two critical uncertainties.

  1. Severe global recession – Moderate global recession
  2. Global credit and capital markets reopen and recover – Global credit and capital markets close down and remain volatile.

By plotting these two axes against each other, four future scenarios are created. You can read more detail about these in the article, but in summary:

Regenerated global momentum

In the most optimistic scenario, government action revives the global credit system—the massive stimulus packages and aggressive monetary policies already adopted keep the global recession from lasting very long or being very deep. Globalization stays on course: trade and capital flows resume quickly, and the developed and emerging economies continue to integrate as confidence rebounds quickly.

 

Battered but resilient

In the second scenario, government-wrought improvements in the global credit and capital market are more than offset—for 18 months or more—by the impact of the global recession, which leads to further credit losses and to distrust of cross-border counterparties. Although the recession could be longer and deeper than any in the past 70 years, government action works, and the global capital and credit markets gradually recover. Global confidence, though shaken, does rebound, and trade and capital flows revive moderately. Globalization slowly gets back on course.

 

Stalled globalization

In the third scenario, the global recession is significant, but its intensity varies greatly from nation to nation—in particular, China and the United States prove surprisingly resilient. The integration of the world’s economies, however, stalls as continuing fear of counterparties makes the global capital market less integrated. Trade flows and capital flows decline and then stagnate. The regulatory regime holds the system together, but various governments overregulate lending and risk, so the world’s banking system becomes “oversafe.” Credit remains expensive and hard to get. As attitudes become more defensive and nationalistic, growth is relatively slow.

 

The long freeze

Under the final scenario, the global recession lasts more than five years (as Japan’s did in the 1990s) because of ineffective regulatory, fiscal, and monetary policy. Economies everywhere stagnate; overregulation and fear keep the global credit and capital markets closed. Trade and capital flows continue to decline for years as globalization goes into reverse, and the psychology of nations becomes much more defensive and nationalistic.

If you'd like to read more about any of these scenarios, have a look at the article.

 

Last updated at 15:08 Mon 18/May/09.
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