World economy now ‘stabilising’

London. Barely five years after the worst financial turmoil and recession since the Great Depression, the US and fellow advanced nations are showing a stability in output growth and hiring last witnessed in the two decades prior to the crisis, in an era dubbed the “Great Moderation.” The lull points to a worldwide economic expansion that will endure longer than most.

Volatility in growth among the main industrial countries is the lowest since 2007 and half that of the 20 years starting in 1987, according to Bloomberg calculations based on International Monetary Fund data. Investors also are becalmed, with a risk measure that uses options to forecast fluctuations in equities, currencies, commodities and bonds around the weakest level in almost seven years.

“That’s why I call it the Great Moderation 2.0,” said John Normand, head of foreign-exchange and international-rates strategy at JPMorgan Chase & Co in London. “It looks, sounds and feels a whole lot like that last time we had reason to use that label.”

Such calm finally is providing a support for equities over bonds and giving companies and consumers long-sought clarity to spend. This doesn’t mean the scars from the slump have fully healed: Growth still is sub-par, and there’s a threat investors will repeat the excessive risk-taking that turned past booms into busts.

GDP growth

The IMF’s latest forecasts suggest output volatility in the Group of Seven nations will ease to 0.4 per cent this year compared with almost 3 percent in 2010 and a 0.8 per cent average in the two decades ending 2007, according to the Bloomberg calculations, which measure the standard deviation in gross-domestic-product growth over rolling four-year periods.

Variability in the growth of employment also has declined to 0.1 per cent this year; it tripled to 1.7 per cent in 2009, calculations for the labour market show.

Trading has chilled: Bank of America Corp’s Market Risk Index closed at minus 1.14 on May 2, the lowest since June 2007. Fluctuations in the $5.3 trillion-a-day currency market also are the lowest in about seven years, according to JPMorgan’s Global FX Volatility Index. “People are catching up to a return to a more normal environment in terms of market volatility and the economy,” said Dominic Wilson, chief markets economist at Goldman Sachs Group Inc in New York.

New reality

The lackluster markets reflect a “new macro-economic reality” in which persistent low interest rates and a focus on boosting employment are delivering greater economic certainty and spurring equities, Ian Harnett, managing director at Absolute Strategy Research Ltd, said in a report published today.

“For now, most of the traits that have typically ended such periods of low volatility - excess leverage and extreme valuations between sectors, stocks and assets - have yet to emerge,” he said.

Professors James Stock at Harvard University and Mark Watson at Princeton University are credited with coining the phrase “Great Moderation” in a 2002 paper titled “Has the Business Cycle Changed and Why?” They found “strong evidence of a decline” in the volatility of US economic activity, attributing between 10 percent and 25 per cent of the shift to the Federal Reserve’s crackdown on inflation. Prophetically, they warned “the past 15 years could well be a hiatus before a return to more turbulent economic times.”

Striking development

The analysis resonated among policy makers, with then-Fed Governor Ben Bernanke calling the apparent quiescence a “striking economic development” in a 2004 speech. A decade later, Wilson’s team is citing old and new trends in explaining why the world is returning to the relative calm it enjoyed before the crisis of 2008, which took down Lehman Brothers Holdings Inc. and global demand.

The shift may reflect how monetary policy is better equipped than it was in the 1970s to stabilise growth and inflation. Economies also have evolved toward less demand-sensitive sectors, such as services, while even manufacturing is less of an economic yo-yo, thanks to efficiencies in supply chains and inventory management.

Stronger regulation

Goldman Sachs sees another explanation: stronger regulation of bank and consumer debt following the crisis means economic growth will be less amplified by easier lending than before. In the euro area, for example, loans to companies and households shrank 2.2 per cent in March from a year earlier, according to the European Central Bank.

The Great Moderation 2.0 still may not prove so great. For one thing, the market calm may not last out the year, given the business cycle will mature and inflation concerns may emerge, according to JPMorgan Chase’s Normand.

“As that risk unfolds, we should see higher market volatility,’ he said. The depth of the recent slump also ‘‘certainly does reveal serious limitations of the concept of a Great Moderation,’’ Jason Furman, chairman of US President Barack Obama’s Council of Economic Advisers, said in an April 10 speech in Washington.