Monday, January 21, 2008

Recession: Will the "Solutions" Hurt the Economy?

In reality only one player has the power to do anything swift and decisive: the Federal Reserve. And its chairman, Ben Bernanke, has already made his intentions abundantly clear. Unfortunately, the cure he's prescribing may be worse than the disease...

It's clear that the economy is losing steam. The plummeting value of America's houses is chilling consumer spending, layoffs are mounting, and banks and other creditors burned by the subprime crisis are far more reluctant to lend to everyone from small-business owners to private equity firms. But GDP increased by 4.9% in the third quarter, and economists estimate that GDP was still growing in the fourth quarter. Exports are strong, thanks to the weak dollar...

So while a recession is a real possibility, it's not inevitable - even the Fed is not forecasting one this year. And if we do get one, it may be brief and shallow, like the one we had in 2001 - with economic growth falling by perhaps half a percentage point for a couple of quarters, and unemployment rising from its current 5% to 5.5% or 6%.

By cutting rates early and often, Bernanke is acting as though a recession - even a mild one - would be a calamity that must be avoided at all costs...

But Bernanke is setting the stage for an even bigger recession down the road. Just as the ultra-low rates of the early 2000s created many of the problems we're experiencing today, pumping money into the system would probably stoke inflation, forcing the Fed to hike rates sharply in the near future. "It's better to take a small recession and kill inflation immediately instead of facing high inflation and a really big recession later," says Carnegie Mellon economist Allan Meltzer.

read the entire article

Anna Schwartz is right. Ben and the boys at the Fed are not up to the challenge.

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