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Friday, November 11, 2011

If Europe is in a recession, how about the U.S.?

by Calculated Risk on 11/11/2011 01:41:00 PM

Yesterday I commented that I thought Europe was probably already in a recession. Since then I have received a number of questions about this comment, especially asking about a recession in the U.S.

First, I do not follow Europe nearly as closely as the U.S., and I was just reacting to the European Commission report that the “recovery in Europe has come to a standstill”. My recession comment was just a guess based on stories out of Europe, and my level of confidence is not very high. So take my comment for what it is worth - very little!

Second, my best guess is the U.S. stays out of recession even if Europe is currently in a recession. Of course there are significant downside risks, especially if there is a disorderly end to the euro.

If we look at the channels of contagion, it seems the impact from Europe – barring a blow-up – will be fairly small. Of course, with sluggish growth, the U.S. is very susceptible to economic shocks, and it also appears that the U.S. is moving to more austerity in 2012 – and that is an additional concern (If Congress does nothing, taxes will increase on working Americans, and more).

What are the channels of contagion from Europe? First, the trade channel – the impact on U.S. exports – is pretty small. Although Europe is a major trading partner, exports only make up a small portion of U.S. GDP. Some of the impact from trade would probably be offset by lower oil prices – and of course lower interest rates as investors seek safety (the European crisis is a key reason the U.S. 10 year bond yield is around 2%).

A more significant channel would be tightening of U.S. credit conditions in response to the European crisis. That is why I looked so closely at the Fed’s October Senior Loan Officer Opinion Survey on Bank Lending Practices that was released on Monday. The survey showed “considerable” tightening on lending to European banks, and some tightening to European firms, but the survey showed no tightening in the U.S. (although lending standards are already pretty tight).

Another possible channel of contagion is less European lending to emerging markets and a slowdown in those economies – and then fewer exports from the U.S. to those emerging markets. This is possible, but we haven’t seen any evidence of this yet. And if emerging markets slowed sharply we’d probably see an offsetting sharp decline in oil prices (hasn't happened).

So, right now, I’m sticking with my general forecast for sluggish GDP and employment growth in the U.S.