Pessimism about the economy now is rampant. GDP expected to drop sharply in the first quarter of this year and perhaps beyond (after an expected steep decline likely to be reported for the fourth quarter of ’08). The unemployment rate has just passed 7 percent, and is widely expected to go much higher before peaking.
I am hardly a pollyana. Around Kauffman I have various nicknames, but Mr. Optimism is not one of them. But despite all of the bad news, I believe there is a reasonable chance the economy will quit shrinking by the 4th, and possibly sometime in the 3rd, quarter of this year, assuming passage of the $800 billion stimulus package (about 3% of GDP per year over 2 years) now being considered in Congress. This will come on top of the continuing large purchases of mortgage-backed securities by the Fed to keep the mortgage market going, the stimulus generated by the huge volume of mortgage refinancing underway driven by the drop in mortgage interest rates, and the cushion to the banking and financial system provided by the spending of the second $350 billion of the TARP funds.
To be sure, once the economy bottoms out, it is unlikely to grow rapidly for all the well-known reasons – it will take a long time for consumers to work off their debts and feel comfortable about spending freely again. But with some luck and the right policy responses, at least a moderate recovery – with GDP growth at or near an annual rate of 3 percent – should be in full swing by some time in 2010.
I know, I know – there is more bad news on the credit front, specifically lots more asset write-downs by banks and other financial sectors, coming. Additional TARP injections or even nationalizations will “fill in these holes,” but by themselves or even with government arm-twisting, these are not likely to encourage understandably risk-averse bankers to increase lending.
But the credit and banking problems are closely intertwined with the real economy: if aggregate demand quits falling and starts to pick up, then banks will be more willing to lend (and regulators will more willing to let them do so). This is why passage of a major stimulus package is key to changing the psychology of the financial system.
Oh, one more thing. As we have learned in this crisis (and should have known before), much about the economy depends on the intangible known as “confidence” or “trust.” Much of it had dissipated by the time President Bush left office, but there is a renewed sense of optimism with Obama’s inauguration. We won’t know yet how long that will continue or whether and how rapidly it will work its way into spending decisions of consumers and investment decisions by businesses. But if I had to guess, it would be that some of the good feeling we saw on the Washington Mall on January 20 will spill over into shopping malls throughout America and provide an unseen, but potentially important boost to a sagging economy. If Congress and the President can cooperate to produce a significant stimulus package soon – even if some of the dollars are wasted, as they inevitably will be – inauguration optimism is even more likely to make its presence felt in the real economy.
None of this will keep unemployment from rising, as it will until economic growth exceeds the sum of labor force and productivity growth (about 2.5% per year). That probably won’t happen until 2010. But, with the right policies, GDP can begin growing again, perhaps sooner than many may realize.
Of course, when the economy does recover, the challenge will be to ensure that it continues to grow rapidly thereafter in a sustained way. That outcome can best be realized, arguably only be realized, through the continued creation and growth of new companies. That, of course, is another subject on which readers will plenty of postings on this blog and at www.kauffman.org.
