The Fed is afraid of a recession. Should you be?
Personally, I'm worried about a slowdown in U.S. economic growth in 2008 to as low as 1.5%, but I think a full-blown recession, in which economic growth turns negative for two consecutive quarters, remains unlikely.
As long as the job market holds up -- and it's holding up surprisingly well -- we'll skirt the edges of an official recession.
Do you agree?
Let's start with Tuesday's actions by the Federal Reserve's Open Market Committee, the group in charge of short-term interest rates.
- Talk back: Do you expect a recession in 2008?
On Dec. 11, the Fed cut short-term interest rates by one-quarter of a percentage point to 4.25%. It was the third cut by the Fed, adding up to one full percentage point, since the central bank began slicing interest rates Sept. 18.
That's the kind of major move that smells of fear. Two kinds of fear.
What has the Fed shaken upFirst, the Fed fears that the debt markets will stop working because banks are so busy writing off billions and billions in bad mortgages and other loans that they'll stop lending. Lower interest rates are a Hail Mary pass flung at the markets in the hope that they will keep banks and investors in the game.
Second, the Fed fears that the problems in the mortgage market, the housing industry and the financial sector, compounded by the effects of rising oil and food prices on consumer spending, will send the economy into a recession.
Inflation is still a worry, the Fed said in Tuesday's post-meeting news release, but not a terribly pressing one: "Readings on core inflation have improved modestly this year, but elevated energy and commodity prices, among other factors, may put upward pressure on inflation. In this context, the Committee judges that some inflation risks remain."
The bigger and growing problem is growth, the Fed continued. "Incoming information suggests that economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending. Moreover, strains in financial markets have increased in recent weeks."
The quarter-point cut in interest rates is insurance against a recessionary slowdown, according to the Fed. "Today's action, combined with the policy actions taken earlier, should help promote moderate growth over time," it said.
Pay special attention to two phrases in that statement:
First, "moderate growth." On Nov. 20, the central bank published its first-ever enhanced economic forecast. In that forecast, Chairman Ben Bernanke and company noted that 2.5% growth was about all the economy could handle in 2008 without triggering inflation. If 2.5% is the speed limit for the economy, then "moderate growth" is south of that.
Second, "should help." Yes, another interest rate cut should help the economy, but it is by no means guaranteed. You might even say it's less likely than usual that an interest-rate cut will help because of the nature of the current slowdown.
Lower interest rates won't add much to home sales because prices are still falling, the supply of housing is still climbing and mortgage money is tight. Lower interest rates won't jump-start the refinancing boom that had kept consumers spending because the drop in home prices pretty much wipes out the chance for most homeowners to refinance and take money out of the equity to spend on other items. Lower interest rates won't lower soaring gasoline and home-heating-oil prices and won't stop food costs from climbing. And lower interest rates won't make loan write-offs at big banks any smaller.
The best that can be said for Tuesday's interest-rate cut is that it won't make anything worse. And even that's not exactly true, since a cut in U.S. interest rates, while rates stay the same in Europe and Japan, is likely to send the U.S. dollar even lower against the euro and the yen.
(By the way, a recent Wall Street Journal survey of 52 economists put the chance of a dollar crisis in the next year at 20%.)
What economists are thinkingBefore the Fed's latest cut, the economists had forecast a 38% chance of a recession in the next 12 months. That was the highest level in three years and a significant jump from the 33.5% chance projected in November.
The U.S. economy is expected to show an annualized growth rate of just 0.9% for the current quarter, the survey found. A month earlier, the economists had projected 1.6% growth for the quarter.
The December survey also predicted 1.5% growth for the first quarter of 2008, down from the 1.9% rate projected in November, and 2.3% growth for all of next year. The economists predicted a 3.5% drop in home prices in 2008, worse than the 2.6% drop they had projected in November.