With today's new GDP figures for Q3, I've updated my forecast. Here's how it looks: That last blue column, the slightly negative one, is last quarter's 0.3% decline. I forecast declines in the current quarter as well as the first quarter of next year.
What will get the economy growing again? That's the most common question I'm getting in my many speeches this fall. We have three problems: 1) too many houses, 2) credit crunch, and 3) weak attitudes among consumers and businesses. Problem #1 won't be solved until we have another year of population growth. Problem #2 is being addressed by aggressive Fed and Treasury policy; I expect it to get solved (see qualification below) in six weeks or so. Problem #3 will be resolved by the many, many people who do not lose their jobs. Right now they are staying away from stores, but after a few months, they'll have paid down credit card balances, or they will have built up their bank accounts. They will say, "We've avoided job loss in this recession, and we have money, so let's spend." That happens in the spring.
The Fed starts draining liquidity from the banking system after six months of improvement, then they have to start raising rates quite dramatically to avoid inflation. Current policy is not inflationary in the current environment (credit crunch and weak attitudes), but it will be inflationary if left in place as credit and attitudes improve. Thus, look for a sharp tightening beginning in late 2009.
The current policy actions may not prove inflationary, but it will take a very deft touch on the monetary helm. The odds of oversteering or understeering are very high, so I'm anticipating a more cyclical economy in the coming years than we've had in the past few years.
Qualification on the credit crunch: When I say that the credit crunch will soon be over, I mean that profitable businesses and prudent consumers will be able to get credit. I don't mean that credit spreads will be as narrow as historical averages, nor do I mean that much real estate development credit will be granted, nor that any sub-prime borrowers will get loans.
My web traffic is way up in the past couple of months (partly thanks to the crisis, partly thanks to Google raising my Page Rank up to 6). Simon Owens has an article here on the PBS web site about how economics blogs are covering the story.
The Fed announced this morning (Wednesday, Oct 29) that it's cutting the target Fed Funds rate by one half percent to one percent. But look at the daily actual Fed Funds rate since July:
Fed Funds has already been trading below one percent for quite some time. Also note how volatile the rate has been lately. I'm not sure that the Fed wants this volatility; it may be very hard to manage the market during such a tumultuous period.
As a general rule of thumb, monetary policy takes about a year to show up in the economy. Right now there's no one who thinks that lowers interest rates is THE solution to the problem. However, lower rates won't hurt, and may help, and may be necessary for the Fed and Treasury to implement the bailout plan. Still, the slogan for this is No Immediate Miracles (which is WIN turned upside down, for those of you who remember Gerry Ford's lapel buttons).
(Note, if you like data and don't want to download to Excel, the St. Louis Fed's data site offers easy-to-manipulate graphics. Go here.)
In the latest issue of the Businomics Audio Magazine I interview economist Rich Vedder, who has just completed a new set of college rankings based on performance, rather than inputs into the educational system. The rankings were published in Forbes Magazine (and incidentally show my alma mater scoring very high.)
The world of finance for small and medium businesses was changing even before this year's financial crisis--but now the changes are galloping.
Money is moving around the world like never before. When you borrow money, even from an American loan officer working for an American bank, the money may well have come from China or Kuwait.
Securitization of business is common--and you may never know that your loan is being securitized.
On top of these on-going trends, we're in a financial crisis triggered by the housing meltdown, subprime collapse, and now a general credit crunch.
I know things are tough for small business, so I wrote a short e-book that explains what's been happening, why the melt-down happened, and what business owners need to do now to get credit in the coming years.
(My ebook website is no longer available, but I'll email a free copy upon request.)
A Seattle bank invited me to speak to their clients, and afterward the bank did something different: they presented a panel of their clients to talk about how the downturn was affecting them. The best part was the tips presented by these business leaders. They covered almost everything I wrote about business strategy in a recession in Businomics. Here are the key points:
Watch your inventory level closely; don't let it get out of hand
Watch trade credit. Be cautious extending trade credit, and collect aggressively
Watch staffing levels. If you are going to have to cut, better to do it early.
If you have some employees who are critical, and you want to keep them even if they are underutilized now, ask them to step up their training and education so that they'll have stronger skills when the economy recovers.
Do more marketing now. Not only will you occasionally turn up new opportunities, but calling on prospective clients helps you keep your ear to the ground. You'll learn earlier about problems your competitors may be having.
Take care of your good customers. They may be having difficulty. Even though the panelists said to watch trade credit, this may be the time you have to stretch to help a few key, loyal customers.
Look at acquisition opportunities; you may be able to pick up a competitor fairly cheaply.
The one point they didn't make that I would add: talk to your banker. Specifically,
Report any bad news early. Your loan officer has an easier time going to bat for you if there have been no surprises along the way.
Ask your banker about your credit quality. Did he have to stretch to get your line approved, or do you lie right in the bank's sweet spot? That's vital information to have.
"Bull markets are born on pessimism, grow on skepticism, mature on
optimism, and die on euphoria. The time of maximum pessimism is the
best time to buy, and the time of maximum optimism is the best time to
Last night Mrs. Businomics and I were doing things we
hardly ever do.I was admitting that I
had been wrong.She was agreeing with
Then I went to read some blogs and
I found Brad DeLong saying exactly what I had been thinking, which is also fairly unusual.The subject: we economists have been wrong
about monetary policy and asset bubbles.
Back in the old, old days, like the 1980s, we had all become
monetarists.Professor Friedman taught
that money supply growth rates should be stable and low.Then financial deregulation, sweep accounts,
and other innovations made the money supply numbers hard to interpret.So we economists looked at inflation, and
the gap between actual output and potential output, to assess whether the Fed
was being loose or tight with monetary policy.
Chairman Greenspan kept interest rates extremely low from
2002 through 2004, and very low in 2005.We weren’t seeing inflation, and output didn’t seem to be surging
excessively, so it seemed that the Fed was not too loose with money.
A few folks worried about asset bubbles being nurtured by
easy money.DeLong cites Michael Mussa,
former research director at the International Monetary Fund, and calls this
view “Mussaism.”The view actually goes
back to much older theories (Don Patinkin for you economists) that can be
thought of this way:folks have three
types of assets: money, investment assets, and consumption assets.If you increase the money supply through
easy monetary policy, then people try to get into asset allocation balance
again, by selling money (also called “spending”) and buying the other
assets.When they are buying
consumption goods, we worry about inflation.
Well, the easy money of the early 2000s did not lead to above-trend
consumer spending; it led to above-trend buying of houses.Some of that buying led to construction of
new houses, but a great portion of the effect was to induce a run-up of homes
prices.Easy money WAS leading to
inflation, just not inflation of consumer goods, but rather housing
inflation.Thus the housing boom, which
resulted in the oversupply of housing, the over-optimism about sub-prime home
loans, and the subsequent financial crisis.Man, I loved Alan Greenspan, but it turns out that he is to blame for
With this view, we have a better understanding of what
happened during the easy money period of the late 1990s, with the high-tech
stock price boom.
We don’t yet have a consensus among economists on this.The theoretical guys will write equations,
then the empirical guys will test them with data.But this feels right in MY gut.
OK, we economists have learned our lesson.Monetary policy must be conducted with an
eye to both consumer price inflation and asset inflation.This lesson does not mean that we economists
are stupid, just that we still have some stuff to learn.Now, lesson learned.
Going forward, once we can get past the current recession,
look for monetary policy to be more cautious.Look for a greater willingness to tolerate small recessions.Look for an avoidance of easy money, and
thus an avoidance of this mistake.
hate to sound like we’re just making this up as we go along, but that’s what I
see.We in the economics profession
learned a lot from the Great Depression.Even in the current crisis, we’re avoiding the dreadful mistakes of the
We learned a lot from the inflation of the 1960s and
1970s.We’ve avoided that mistake ever
Now we have a new lesson, and we’ve learned it.Monetary policy won’t be error free in the
future, but I’m highly confident that we economists … will learn from our
(I also realized I didn't explain the logic behind the TED spread. If it's obvious to you, skip this paragraph. When banks have extra cash lying around, two of the choices on how to invest it are to 1) deposit it with another bank, or 2) buy Treasury bills. Treasury bills are the safe choice, but pay a low interest rate. Depositing with another bank isn't quite as safe as buying T-bills, but it usually comes very, very close to being as safe. Just how close the risk of a bank is to the risk of the U.S. Treasury can be seen in the TED spread, which is the difference between LIBOR (London Interbank Offered Rate) and the yield on T-bills. It's the extra interest that a bank has to pay to get another bank to make a deposit rather than buying T-bills. And we're not talking about deposits at small country banks, but the major London banks.)
To the TED spread I have added the difference between yields on junk bonds and U.S. treasury bonds.
I don't think there's anything to be learned from comparing the levels of the two spreads; I use this chart to help compare current events with past events. (Unfortunately, I can't find a good junk bond data series that goes back very far, because prior to Michael Milken, there was little interest in junk.) By the way, the most recent daily observation on the junk spread is much higher than the September monthly average, but it's a bit misleading to throw in a single day when the rest of the data are monthly averages.
My economic forecasting implication of the financial crisis: this is not outside the range of what we've lived through in the past.
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