Tuesday, September 18, 2012

US economy not like aircraft with stall speed - BIS paper

    The use of the aeronautical term "stalling" to describe the U.S. economy's low pace of growth is problematic because economies - unlike aircraft pilots that crash if they make mistakes - are self-correcting and ultimately return to growth, according to a paper from the Bank for International Settlements (BIS).
    Some commentators have compared the U.S. economy to an aircraft, saying it is close to "stall speed" when it will lose altitude, spin downward and crash without pilots having any control. The implication is that the U.S. is close to plunging into a new recession, the feared double-dip.
    But Wai-Yip Alex Ho, manager at the Hong Kong Monetary Authority (HKMA) and James Yetman, senior BIS economist, find several problems with this analogy in their working paper: "Does US GDP stall?"

    One problem is that there are several meanings of stall. One interpretation is that the growth rate of an economy is too low to sustain normal growth and this ends in recession. Another interpretation is that economic growth slows below some threshold and normal growth is no longer sustained.
    In either case, the authors point out that economies typically transition through low growth when  entering and exiting recessions, suggesting that economies may be more like gliding aircraft, highly inertial and it takes time for pilot inputs, in the form of fiscal and monetary policy, to influence the speed of the economy.
     But the real problem is that economies are not like aircraft. If economic growth slows, wages and prices eventually adjust, supporting demand, so recession gives way to growth. Policy can smooth the path of the business cycle or make it more turbulent.
    "But ultimately the economy will grow again, regardless of pilot input. In contrast, if an aircraft stalls, there are no self-correcting mechanisms at work. Failure by the pilots to apply the correct inputs will lead to a crash and loss of both the aircraft and its passengers. Perhaps we need a better analogy, based on a cycle that is ultimately self- equilibrating, like the business cycle," the authors write.


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