AEI Economists' Assessments of Recession Risk Vary
WASHINGTON, APRIL 29, 2008 -- Is the U.S. economy in a recession? If so, how long will it last and how much will it hurt? Six AEI economists offered differing assessments at a panel discussion yesterday, ranging from Charles W. Calomiris's view that "severe recession risk is minimal" to Desmond Lachman's prediction of "several quarters of negative growth going forward." Other panelists--including former Federal Reserve monetary affairs director Vincent R. Reinhart--addressed the Fed's role in the credit markets, especially its March bailout of Bear Stearns.
The panelists took a fresh look at the health of the economy, meeting for the first time since their December 2007 panel. Then--as now--Calomiris argued that "it is too early to conclude that the U.S. banking system will find itself unable to reallocate risk in an orderly fashion, and end up having to dramatically curtail the supply of credit." He pointed to signs today that banks are reabsorbing off-balance sheet items and that the banks' liquidity risks from asset-backed commercial paper and special investment vehicles are contained. He added that banks have sufficient access to capital markets and that "corporate balance sheets are strong."
Kevin A. Hassett offered an analysis of whether the economy is in recession based on a model he is helping to develop. In December and January, he said, it was not; but the data "took a marked turn for the worse in February," although "it's not obvious that we're in recession yet." Hassett added that an impending recession combined with the presidential election might result in "tax policy uncertainty" in the financial markets, which in turn might harm growth.
Lachman argued in December that a recession was imminent, and he said yesterday that the three "negative economic shocks" he identified as leading toward recession had gone from bad to worse: the housing bust, the credit crunch, and rising oil prices. On housing, he predicted a further 20 percent drop in value to reach equilibrium. Lachman described the recent sharp rise in foreclosures as "off the charts." Not only are we in a recession, he said, but "unorthodox measures are needed to stabilize the housing market."
John H. Makin echoed some of Lachman's comments when he said: "Everything looks like we went into a recession in the first quarter." Of the Fed's Bear Stearns bailout, he said that it was necessary to prevent a run on investment banks and "a near meltdown in the credit sector." The Fed's action was to be commended, he added, since it had stabilized financial markets.
The Fed's decision "to lend to Bear Stearns and extend lending to all primary dealers . . . was the [Fed's] worst policy decision in a generation," Reinhart countered--comparable in its long-term consequences to the errors of the "great contraction" of the 1930s and the "great inflation" of the 1970s. He said the Fed's decision reflected "panic" that overlooked other tenable options. Among the consequences of the Fed's action, Reinhart said, will be the central bank's loss of credibility as an "honest broker" in financial crises and, more disturbing yet, a possible wave of poorly designed financial reregulation.
Allan H. Meltzer, a historian of the Fed, called for the central bank to take a longer view and to remain mindful of rising inflation expectations. He is pleased with its role in safeguarding the financial system but not with its weak-dollar policy, and he feared that the Fed is ignoring inflationary risks, much as it did in the 1970s. Part of the problem, he said, is that "most of the time, the Fed is not independent . . . it's whipped around by the Congress." Chairman Ben S. Bernanke is not "standing up" to Congress, and he is "also under the gun from Wall Street."
--EVAN SPARKS
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