The concept of “escape velocity”

Consumer demand, Economic growth, Financial Events

Summers.jpgThis being Budget Week in the blog, it seems appropriate to look at the views of Larry Summers, US economics chief, to understand his expectations for an economic recovery. His main concept is of “escape velocity”, whereby the economy will escape from the downturn like a 3-stage space rocket:

• Government spending stops the downturn becoming worse
• Companies rebalance inventories
• Consumers gain confidence, and begin spending again

His core argument is that “the deepest recession since the Great Depression hasn’t changed the growth potential of the U.S. economy“. But Summers does concede that “we’ve got a substantial period ahead of us until we get back to a fully satisfactory state for the American economy.”

Probably the key issue is what happens to US consumer spending. This accounts for 70% of US GDP, and 16% of global GDP. It is worth $10trn, versus total Asian consumption of under $5trn. Summers’ argument is that spending will recover if confidence can be restored. The alternative view, argued by Pimco, the world’s largest bond fund managers, is that the US consumer will not return to the spending patterns of 2003-7.

Unemployment is the key indicator that will decide the winner of this debate. Consumers don’t spend if they are jobless, or worried about job security. If companies continue to cut jobs, then Summers’ concept of escape recovery will likely fail for lack of fuel.

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