Bernanke’s Trial by Fire, Act II: Recession Obsession and a Little Stimulus

Bernanke’s Trial by Fire, Act II: Recession Obsession and a Little Stimulus

In less than two years on the job, Federal Reserve Chairman has been forced to deal with two fairly significant market crises. First was last summer’s credit market meltdown fueled by ballooning residential mortgage foreclosures, which forced the Fed into emergency reductions of the discount rate and pumping extra liquidity (i.e. cash) into the system. On this past Tuesday, Fed members agreed to an emergency 75 basis point cut in the funds rate a week before their regular meeting due to growing fears of a U.S. economic recession. To allay fears further, the FOMC is widely expected to cut rates an additional 50 basis points next week, and it is possible the rate could be reduced to as low as 2.5 percent by years end.


Sentiment has clearly taken a turn to the gloom-and-doom side. Opinion has swung such that many economists are no longer questioning when a recession will occur (or if we are already in one), but “How long and how bad will it be?” For a look at some recession-related myths, see this article by Kevin Hassett of the American Enterprise Institute; opposing opinions on the direction of the economy can be found here: positive and negative.


From a broader perspective, we don’t see an impending recession but rather a period of weak growth, likely to the tune of a 2% gain in real GDP during 2008. Although the housing market will drag things down, the overall picture is positive since corporate profits remain high, business inventories are not bloated, and consumer spending is holding steady. Regardless of where the economy is headed, we will see pockets of weakness and the electroindustry has likely already found itself on the side of much slower growth compared to the past few years, as evidenced by the fact that the EBCI has spent the majority of the last 12 months below 50.


With all the bad news from earlier in the week, lawmakers and President Bush wasted no time in reaching a preliminary agreement on an economic stimulus package. The $140 billion price tag on the package includes tax rebates up to $600 per person (or $1,200 per household) and capital equipment expensing incentives for businesses. Also, the deal expands the cap on mortgage loans eligible for reselling to Fannie Mae and Freddie Mac up to $729,750, depending on metro area. Some analysts view (subscription required) this latter policy change as a potentially dangerous one that would lead to a drastic increase in risk. For a more detailed description of the proposed legislation’s provisions, see here (subscription required) and to have an example of how not to structure an economic stimulus package, see this article.

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