Monday, January 14, 2008

economic stuff

Business Times - 15 Jan 2008


Not saying the R-word - but alluding to it a lot

Bush concedes 'economic challenges' and the Fed stands ready to take 'substantive action'

By LEON HADAR
WASHINGTON CORRESPONDENT

FEDERAL Reserve chairman Ben Bernanke was asked whether he expects, as the questioner put it, 'the R-word'.

'The Federal Reserve is not currently forecasting a recession,' Mr Bernanke responded after his address in Washington last week. 'We are forecasting slow growth.'

Then he added: 'But as I mentioned today, there are downside risks and, therefore, it's very important for us to stand ready to take substantive action to address those risks and provide some insurance against those negative outcomes.'

Since the start of the downturn in the American economy - the housing crisis; the credit crunch; the high oil prices; signs of unemployment and lower spending - US officials and lawmakers, including the head of the central bank, have refrained from using the R-word.

If we accept the standard definition of a recession, as offered by Wikipedia to be 'a decline in any country's gross domestic product (GDP), or negative real economic growth, for two or more successive quarters of a year', we'll be able to conclude that the US was in a recession only after that recession had actually taken place. But if you consider the nuances in the statements about the issue that are being made in Washington these days, it does seem that the Bush administration and Congress are operating under the assumption that the recession has, indeed, begun.

No one is using the R-word - but it's hanging out on the tip of everyone's tongue. Hence, after a government report last Friday showed that unemployment jumped to 5 per cent last month from 4.7 per cent in November, even President George W Bush had to admit that the economy was in bad shape. In a somewhat downbeat speech in Chicago, Mr Bush said that America was facing 'economic challenges' as a result of the home mortgage crisis and the other economic pressures.

'We cannot take growth for granted,' he said in a speech to a group of midwestern business leaders, acknowledging that 'recent economic indicators have become increasingly mixed'.

You don't have to be a Fed chairman to sense the rising unease among businesses and consumers over the economy. Adding to the bad news on unemployment have been signs of a drop in consumer spending and the rise in credit problems. The retail chains have reported a dramatic fall in sales in the recent holiday season. American Express and Capital One, two of the largest credit card companies, are experiencing rising problems with credit card holders who are failing to pay their debts, reflecting growing credit problems around the country. And there are new reports each day about more defaults on mortgage loans.

At the same time, the dramatic increase in oil prices amounts to a tax on consumers and businesses, and depresses their spending (while also putting upward pressures on inflation). The fall in housing prices and the uncertainty about share prices on Wall Street have a negative 'wealth effect' for those who have invested in the housing and stock markets. They sense that they have less money to spend.

Mr Bernanke seemed to be trying to respond to these and related developments in his speech last Thursday, stressing that the Fed 'must remain exceptionally alert and flexible, prepared to act in a decisive and timely manner and, in particular, to counter any adverse dynamics that might threaten economic or financial stability'.

In practical terms, by suggesting that 'additional policy easing may well be necessary', Mr Bernanke made it clear that he and his colleagues in the central bank will be ready to cut the short-term interest rate by half a percentage point at their meeting at the end of the month.

In theory, such a decision to cut the interest rate on Jan 30 could help stimulate the economy by encouraging businesses and consumers to borrow and spend, and as a result, could avert the recession.

By hinting at interest rate cuts, the Fed will be signalling that it is less concerned about inflation, which Mr Bernanke did last Friday, noting that 'inflation expectations appear to have remained reasonably well anchored, and pressures on resource utilisation have diminished a bit'.

And if Mr Bernanke hopes that the central bank could prevent recession by using its major policy tool (interest rates), President Bush and his aides, as well as Republican and Democratic leaders, are trying to come up with other policy ideas aimed at aborting recession or at least make the economic downturn less destructive.

Mr Bush and the pro-business Republicans have continued to stress the need to provide tax breaks for businesses and consumers. 'In a time of economic uncertainty, we don't need to be taking money out of your pocket,' Mr Bush said during his speech in Chicago. 'The smartest thing we can do is to keep taxes low.'

The Democrats, at the same time, have called for more emphasis on a fiscal stimulus through government spending, especially by providing financial assistance to people at the bottom of the economic ladder, in the form of increases in unemployment benefits and food stamps, in addition to tax rebates for low-income workers.

Most observers expect the administration and Congress to begin soon debating their various policy options and to come up eventually with a stimulus package that would include a mix of mostly targeted tax cuts and new spending projects.

The debate is bound to highlight concerns among economists that the increases in government spending could also lead to an expansion in the federal budget deficit. The long-term danger posed by such an expansion was dramatised by reports this week that the US was at risk of losing it triple-A credit rating within a decade unless it took action to curb the rising government spending on healthcare and on its national pension programme, aka Social Security.

Fiscal stimulus coupled with interest rate cuts by the Fed and the infusion of more credit that would discourage saving could also make it less likely that the structural economic problems relating to its growing current account and trade deficits will be resolved.

Moreover, the new credit could end up providing incentives for businesses and consumers to continue with their irresponsible behaviour that led to the current housing mess and by extension, the credit crunch, in the first place.

Finally, by cutting interest rates, the Fed could put further downward pressure on the weak US dollar. A weaker dollar is supposed to make imports more expensive (and exports cheaper) and thus help reduce the trade deficit. But the US trade deficit actually expanded to its highest level in 14 months in November as imports, especially of oil, surpassed growth in exports.

Clearly, the US economy is in for rough ride in the coming months.

Copyright © 2007 Singapore Press Holdings Ltd. All rights reserved.

3 comments:

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Business-Development-Metrics.com said...

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Tejvan Pettinger said...

I think the likelyhood of a recession in the US is pretty high now. Unfortunately the economy has many fundamental problems; it would be hard to avoid a slowdown. The trick will be to manage it so that it avoids a serious recession


http://www.economicshelp.org/2008/01/what-went-wrong-with-us-economy.html