Recession and Inflation Imminent?

Great Debates
#1

With the Fed decreasing the discount rate to avoid a recession and continued inflation, is the US economy going to grind to a halt like Japan? Paul Krugman wrote an article a couple years ago that warned of parallels.

Here is a link that explains Japan’s economic woes. With the housing bubble bursting here in the US, banks will be burdened with bad debts. We have had our manufacturing shifted abroad which so far has sent unemployment to 4.6% in Jul 2007 (cite). Which isn’t bad. So that hasn’t been paralleled yet.

Granted, inflation isn’t soaring but core inflation is still worrisome (article). Add to all this pressure, the US trade debt. Something’s gotta give, right?

It doesn’t look like money supply is the issue, it looks like money management and improper allocation of assets are the problem. Thought?

#2

Paul Krugman, like any good political pundit, knows how to hedge his bets, because he’s written equally scary articles warning of DEflation. So he’s ‘right’ no matter which way it goes.

Unless, of course, inflation just remains low and stable. Then Krugman is wrong either way. And that’s exactly what it’s been doing for over a decade. Mind you, it could be that Bernanke isn’t as good at this as Allan Greenspan was, and he’ll let inflation or deflation get out of control.

In any event, unemployment is at or near historic lows, and about what economists think is full employment. In fact, there are signs that wages are rising because of the need to attract employees, which is good for workers but is certainly a potential inflationary force. Also a bit worrying on the inflation side is the amount of capital that has been injected into the financial markets to stabilize them.

I don’t buy the parallels to the Japanese crash. The Japanese real-estate bubble was much more severe - there was a point at which the grounds of the imperial palace in Japan were, on paper, worth more than all the commercial real-estate in Canada. The Japanese have other problems - an aging population, an insular culture that discourages immigration, and a subsequent upcoming population crash. Japanese culture seems somewhat dysfunctional in other ways as well.

It’s not clear yet whether we’ve seen the worst of the real-estate bubble pop, or if there’s lots more to come. But the U.S. economy grew at 4% last quarter, which is well above average. So there’s plenty of room for it to come down without falling into an actual recession.

#3

For those who have access to Times Select, please link to the column where Krugman wrote of simultaneous inflation and recession.

This sounds wrong. The Japanese case is one of deflation and recession. A spell of stagflation today sounds unlikely (though recession is plausible).

Krugman is a fine economist. I believe he has been unintentionally misrepresented.

#4

Inflation, by the way, is pretty well contained: the core PPI came out at 1.9% today, within the Fed’s 1-2% comfort range. Which is too low, in my view.

The Fed decreased the discount rate to avoid a liquidity crisis. People were calling their money market fund to ask whether they held any collateralized debt obligations (CDOs). If the answer was yes, some would switch to the Treasury Fund.

Which is just peachy, except that money market funds also held commercial paper, most of it fundamentally sound. Which had to be sold to raise cash for all that Treasury debt being bought.

The Fed stepped in with open market operations (lowering the effective fed funds rate to 5% at times) and encouraging banks to lend to those with fundamentally sound finances.

#5

One structural difference between the US and the Japanese economy is that US business have ways to quickly write off bad debt. While this doesn’t avoid the initial pain from something like the housing bubble, it prevents the pain from draggin on indefinitely. My understanding (and I’m willing to be corrected here), is that the Japanese are unable to do the same for political and cultural reasons.

#6

Here is a free snippet. His argument was fully articulated in his book. Also, isn’t insufficient demand a recession?

#7

No, it isn’t. A recession is defined by two quarters of negative growth. Insufficient demand could lead to a recession, but ultimately, assuming a free market, market price will fall to meet demand. Other things would have to happen, other than no interest in a product. Producers themselves would realize a loss, but all the businesses required to make a transaction happen in the first place are most likely fixed costs, and not dependent on whether an entity can sell its wares. Like I said, once this factor comes into play, prices should have fallen to meet demand, because it’s better to make some money (even at a loss) than make no money at all. I recall reading an article from The Economist (like in April or maybe May), that stated that the US didn’t even have one in 2001, or it was so mild reflecting on how good and flexible the US economy is and how good the Fed is at controlling the interest rate.

As to the OP, we are well different from Japan, as it was stated, we didn’t have stagflation and a recession. Additionally, having inflation and a recession, I agree, sounds fundamentally impossible. How could things cost more if the overall growth of the market is declining?

#8

I read that book; I read the snippet. Nothing in either suggests that Krugman is worried about stagflation in Japan or the US.

Insufficient demand can lead to recession or a lengthy spell of slow growth, as Japan experienced.

Japan experienced falling prices -deflation, not inflation- which were a real problem. When prices are falling, the central bank loses the ability to cut real -inflation adjusted- interest rates. That is, if prices are falling by 2%, the central bank could cut its key interest rate to a quarter of point, and the real lending rate would still be a hefty 2.25%.

In contrast, the US’s real fed funds rate can drop to .25% during a downturn. (It averages at about 2.75% though).

mazinger_z describes a situation where falling prices make everything better: conventional wisdom has it that the Great Depression and the Japanese experience in the 1990s to now disprove that POV.

Stagflation, which the US experienced in the 1970s, is a separate problem. That involves rising prices -inflation- along with falling output, or recession.

It can occur when there’s a supply shock. When OPEC cut back on the supply of oil, the economy adjusted via a mix of higher general prices -and even higher inflation or higher percentage increases in the price level- and lower output. Unpleasant.

Again though, the latest report shows core inflation at 1.9%, which is within the Fed’s 1-2% comfort zone. Separately, I think their comfort zone is too low, for reasons given above.

#9

When things get out of control, in retrospect it was always a simple trigger that initiated it.
Panic in the markets is as hard to predict as riots in a city. Sometimes a losing ball game will cause a chain ending in widespread damage and death, while other times a million people can march on Washington without major incidents.
So, not to scare you, but any market oddity at all may be the harbinger of doom.