Economics in the Morning

I gave a talk at the South Hadley Chamber of Commerce's annual economic forum this morning. It was a breakfast meeting in which they asked a financial planner and me to talk for 15 minutes or so and then we took questions. The topic was the State of the Economy. Here is my take:

We are recovering from a textbook recession. Despite all the fear and angst a year ago, this is not the Great Depression and the world did not end. GDP fell, and now it is rising. The people who are doubting that the recession is over note that things are still bad; but that is the point--the recession ends and growth starts by definition at the lowest point. The recovery will take some time--nobody is sure how long.

There are many things going on that are interesting, but there are two which particularly intrigue me. First, the lack of a financial regulation bill. When I spoke at this event last year, I noted that we could be certain that there would be a new set of financial regulations in 2009. I was wrong. Washington has been obsessed first with the Stimulus Bill and then with the health care bill, so this rather important bit of legislation has not been discussed at all. The lack of action on a new regulatory bill is certainly slowing down the recovery of the financial markets--financial firms have no way of knowing what sort of activities will be prohibited or encouraged in future regulation.

The second intriguing thing is the possible inflation in the future. The Fed has increased the monetary base (essentially bank reserves) by a substantial amount. In normal times this would lead to a very rapid increase the money supply and thus a high inflation rate. At present banks are hoarding reserves, largely because they are still nervous about the financial and regulatory climate. The Fed is promising to act before the money supply has a chance to go up. This sounds nice--and this is certainly possible to do on a chalkboard. But, no country in the history of the world has ever done what the Fed is pledging to do. So, either they will pull off the greatest act of monetary management we have ever seen or we are going to see double digit inflation at some point in the next few years.


The questions ranged all over; the comment I made that seemed to arouse the most opposition is that there is nothing in this recession that is fundamentally different than what we have seen before. I have seen this before--many people really want to believe that this recession or the reaction to it are completely without precedent. I have no idea why people want to believe in the novelty of the economic events of the last two years.