06 October 2010

Odds of Double Dip Recession High

Yesterday, Goldman Sachs estimated the odds of a double dip recession at 25%-35%. Another noted analyst put the odds of a double dip recession at 40% today. Krugman is talking about a period of stagnation worse than Japan's lost decade ahead because we haven't taken decisive enough Kenysian action. The other doomsayers are less eloquent, even though they are more quantitatively specific, so I'll quote Krugman, who didn't pin down a number (via Ezra Klein):

There's a trap, and it's the same thing that happened with fiscal stimulus. You do something in the right direction that's inadequate, and then people say, well, that didn't work, and instead of increasing the dosage and proving it right, you give the thing up altogether.

All of this is very familiar if you studied Japan in the '90s. In fact, we're doing worse than the Japanese did. Our monetary policy is a bit more aggressive, but our fiscal policy has been less aggressive. We have a larger output gap than they did, and we've had a surge in unemployment that they never had, and our political will to act has been exhausted much faster than theirs was. On the current track, we're going to look at Japan's lost decade as a success story compared to us. What we should be doing is a really big dose of stimulus on all of these fronts. Throw the kitchen sink at it. But if you ask me for ways to solve this problem that lives within the constraints of policymakers who don't want to be bold, I don't know that I have an answer for that.

Of course, there probably won't be a double dip recession even by these accounts, and Krugman is more bearish on our prospects than most.

There are also reasonable reasons to doubt that monetary policy (basically increasing inflation to make real interest rates effectively negative, and buying vast amounts of private sector debt at low rates on debt risker than public sector debt, since nominal interest rates on risk free Treasuries are near zero) would be very effective at this point.

Still the odds of a double dip recession are frighteningly high for something so ugly, and the expected par for the course expectation is pretty mediocre. What people aren't predicting is very likely is an intense boom to swiftly erase the harm caused by the recession.

Indeed, even though our gross national product is now slowly increasing, meaning that we are official in the process of recovering, unemployment (which is generally a lagging indicator) continues to be a problem, and the number of private sector jobs in the economy actually fell in September despite the fact that the number of jobs in the economy needs to grow simply to keep the unemployment rate constant because the labor force is constantly growing as our population grows.

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