Thursday, January 10, 2008

Do you stimulate? 

The weakness now appearing to take hold in the U.S. economy is setting off a number of policy moves in the Bush Administration and in the Federal Reserve. Let's look at both of those areas.

Despite most people trying to say the news is good, there have been a series of reports this week that point in the other direction. From the morning memo of The Economist:
American retailers announced lackluster sales in the all-important month of December. While Wal-Mart enjoyed a small increase in same-store sales of 2.4 percent, numbers were down at Target, Macy's, and the Gap, among others. Piling on with more bad news is Capital One Financial, which lowered its full year guidance by 20 percent on rising loan delinquencies.
We will get the retail sales figure on Tuesday, and it would be hard to imagine it going up very much on a seasonally adjusted basis. Menzie Chinn has a look at the current data and a collection of articles saying we're already in a recession or at the precipice. I doubt we will know the peak of the expansion for several months yet, but if the NBER is releasing new memos on dating of the business cycle I'd assume they are closely scrutinizing the data.

The Bush administration is looking at a small fiscal stimulus, largely in the form of tax rebates and investment tax credits. A mix of tax cuts and spending increases seems likely, particularly in an election year. But researchers don't think the tax stimulus package will be very effective, and perhaps not well-timed.

Moreover, most of the softness in job growth seems to be coming from credit-sensitive areas like construction, retail sales and financial services. Areas like education and health, or professional and business services, have proven to hold up a little better. So it may be that the path of interest rates over the next six months will be determinative of where we're going. Greg Ip notes that it might matter to the incumbent party as well -- when the Fed has lowered interest rates (usually for countercylical macroeconomic stabilization reasons) in an election year, the incumbent party is only batting .200 for re-election. Bernanke signaled this morning that the risks of recession have gotten worse, not better.
Although economic growth slowed in the fourth quarter of last year from the third quarter�s rapid clip, it seems nonetheless, as best we can tell, to have continued at a moderate pace. Recently, however, incoming information has suggested that the baseline outlook for real activity in 2008 has worsened and the downside risks to growth have become more pronounced. Notably, the demand for housing seems to have weakened further, in part reflecting the ongoing problems in mortgage markets. In addition, a number of factors, including higher oil prices, lower equity prices, and softening home values, seem likely to weigh on consumer spending as we move into 2008.
Bernanke will testify before Congress on the 17th, and I expect a similar signal at that time. The last meeting of the FOMC was a bit chaotic with divergent opinions, and I think that might be because Bernanke was still hedging the two poles of high employment and price stability. It appears from those remarks that his mind is made up, and I'd expect his leadership will lead others to follow suit (though it appears at least one Fed president is still whistling the inflation hawk's song.)

John Palmer worries about overreaction in Canada.
Remember what happened back in the late 70s and early 80s? ... Our economies faced sectoral dislocations and rising unemployment as we encouraged search via the provision of a higher social safety net. Trying to avoid and correct the rising unemployment rates, gubmnts provided additional stimulation to the economies, and mostly what we got was an upward spiral of stimulation, inflation, stimulation, inflation, etc.

Let's hope the gubmnts and central banks of today can do better. For sure, one thing they must do is avoid the temptations and pressure to over-stimulate aggregate demand.
He is not hopeful of the Harper government heeding that caution. If we're to avoid that, I expect it falls to Chairman Bernanke to save us rather than the Bush Administration.

UPDATE: After Bernanke's prepared speech today he took questions, and was asked whether he expected a recession. The WSJ reports his response:
Let me tell you a story. Before I got this job, before I was even on the [Federal Reserve] board, I was a member of the NBER business cycle dating committee which is actually the official body that determines the dates of the R-word as you referred to it. And one of the things that was striking about that operation is we didn�t even sit down and think about it until six months after the event. And the reason we didn�t do that was because economic data being as volatile as they notoriously are and as subject to revisions as they notoriously are, you really can�t make a determination about that kind of thing until well after the event. And so that�s what we did in that particular episode.

What was ironic about it was even though we waited quite a while to make a determination, subsequent to our determination there was yet further revisions of the data, further information, that you know cast doubt eventually on our dating. It just goes to show you how difficult these things are to interpret and evaluate.

The Federal Reserve is not currently forecasting a recession. We are forecasting slow growth. but as I mentioned today there are downside risks and therefore it�s very important for us to stand ready as I mentioned to take substantive action to address those risks and provide some insurance against those negative outcomes.
Interested readers should refer back to this post by Jim Hamilton FMI on the controversy of whether the last recession started in 2000 or 2001.