Wednesday, January 23, 2008

We shouldn't panic about the economy

It's easy to get the impression from the media that we're a.) in a recession and b.) the recession will be long and deep.

I saw a quasi-economist from Fortune Magazine on the Colbert Report last night getting grilled but speaking the truth: We don't know if we're in a recession, or if there will even be a recession. We don't know until after the fact.
We can look at some indicators, some traits that were common before the economy entered previous recessions, but there are few universal indicators. And conditions change. Who's to say a previous indicator will still be applicable now?

In the Democratic debate last week, Hillary blasted Bush for waiting "too long" to put out a fiscal stimulus. I've heard other Democratic spokespeople on CNN criticizing Bush for saying for so long that the economy was healthy and growing (implying that it's obviously not). That's ridiculous. The economy has been strong and growing! The unemployment rate has fallen as jobs have been created in the past two years. It's only recently that things have slowed down, and they might not be going backwards. And no one, including Bernanke back in May, foresaw the depth of this crisis. It's as ridiculous as the claim that Bush's tax cuts only helped the rich. I've written the truth on this before.

A better question is: Do we really even need a $150 million fiscal stimulus?

Mankiw points to Alan Blinder's research that says:

"Under normal circumstances, monetary policy is a far better candidate for the stabilization job than fiscal policy. It should therefore take first chair. Nothing in this paper is intended to dispute this piece of conventional wisdom. That said, however, there will be occasional abnormal circumstances in which monetary policy can use a little help, or maybe a lot, in stimulating the economy—such as when recessions are extremely long and/or extremely deep, when nominal interest rates approach zero, or when significant weakness in aggregate demand arises abruptly. To be prepared for such contingencies, it makes sense to keep one or more fiscal policy vehicles tuned up and parked in the garage, and perhaps even to adopt institutional structures that make it easier to pull them out and take them for a spin when needed."


And Mankiw wonders if 5% unemployment and 1% (positive!) growth predictions for next year qualifies as an "abnormal circumstance."

The Washington Post also has a somewhat humorous article about the "5 Myths About That Depressing R-word." The author quotes this paper from the Romer family (David Romer is the same guy that proved you should never punt on 4th-and-short on your opponents' territory) that says:
"We analyze the contributions of monetary and fiscal policy to postwar economic recoveries. We find that the Federal Reserve typically responds to downturns with prompt and large reductions in interest rates. Discretionary fiscal policy, in contrast, rarely reacts before the trough in economic activity, and even then the responses are usually small. Simulations using multipliers from both simple regressions and a large macroeconomic model show that the interest rate falls account for nearly all of the above average growth that occurs early in recoveries. Our estimates also indicate that on several occasions expansionary policies have contributed substantially to above normal growth outside of recoveries."


In other words, the Fed rate cuts do most of the work and fiscal stimulus is often too late and unnecessary.

Bill Conerly at Businomics also reminds us that the stock market does NOT equal the economy.
Note this graph:

Stock prices are much more volatile than GDP and are not always a good indicator of what the economy will do. (Conerly predicts slower growth but no recession). So, don't watch your nightly news, see the dow dropped another 100 points and think it must mean a recession.

Now there are some (besides Barack Obama) who think that there will indeed be a recession and that it will be extraordinary and deep because the housing market hasn't bottomed out yet and credit is extraordinarily tight. But no one knows! Over at Intrade, the recession prediction for 2008 is now at 69%, down from 75% a couple days ago. So, 3 out of 10 people are betting on no recession at all.

There's no need to panic in any case, and no need to point fingers at Bush, as though he is a wizard of the economy. It also takes a full year for any change in interest rates to fully make it's way through the economy. That means the Fed's first rate cuts earlier last year haven't fully worked their benefit through the system yet. Yesterday's cuts will also take a full year to reap full benefits.

Any fiscal stimulus is likely to take just as long. I'd say, in the long run, the risk of further breaking the bank by increasing the deficit through fiscal stimulus must be taken into consideration when calling for a fiscal stimulus package.

1 comment:

Daniel said...

Hey buddy,

I just wanted to say that you are right on the money.

I have tried to say the same thing many times, but have fallen woefully short of doing it with anything near the eloquence and brevity that you did.

Bravo.