Roubini’s Dilemma

In the RGE Monitor (July 16), Chairman Nouriel Roubini (also Professor, New York University, Stern School of Business) a leading and acute observer and forecaster of the economy explains why a “double-dip W–shaped” recession is a real risk toward the end of 2010, even though he expects – as he consistently did – the end of 2009 to mark a pause in the current contraction. This great recession would then have lasted 24 months and thus “been three times longer than the previous two and five times deeper –in terms of cumulative GDP contraction – than the previous two.”

Here is the 2010 dilemma:

“I see a shallow, below-par and below-trend recovery where growth will average about 1% in the next couple of years (…) the recovery will be weak given the debt overhang in the household sector, the financial system and the corporate sector, and now there is also a massive re-leveraging of the public sector with unsustainable fiscal deficits and public debt accumulation. (…)

on one side, early exit from monetary and fiscal easing would tip the economy into a new recession as the recovery is anemic and deflationary pressures are dominant. On the other side, maintaining large budget deficits and continued monetization of such deficits would eventually increase long term interest rates (because of concerns about medium term fiscal sustainability and because of an increase in expected inflation) and thus would lead to a crowding out of private demand.”

Thus “the exit strategy for monetary and fiscal policy easing will be daunting.”

The task will prove even more difficult in Europe, where the eurozone currency has been consistently overvalued while national activity trends are markedly diverse.