Recession

U.S. Economy May Slip Into a Recession

The latest remarks from Ben Bernanke revealed his beliefs that the U.S. economy would have little, if any, real gross domestic product growth for the first two quarters of 2008. Bernanke goes on to say that RGDP could even “contract slightly”. This in itself, defines a recession, but there is much more information to confirm that the U.S. is headed for a recession.

One of the first indicators of a looming recession is the decline in homebuilding, employment, and consumer spending. These characteristics are certainly representative of a bust, affecting consumption in the expenditure approach. Another good indicator is that orders to U.S. factories “fell more than forecast” (Lanman). This shows that the economy did not correctly account for the reduction of exports, which also affects the expenditure approach. Finally, according to the article, the economy was said to have grown .6% in the last quarter of 2007, and then only .2% in the first quarter this year, both of these being Nominal GDP. Now according to the Fed, the inflation rate has “increased at least two percent from the year earlier” (Lanman). This would make the Real GDP -1.4% for the last quarter of 2007 and -1.8% for the first quarter of 2008, or a decreasing RGDP, for two consecutive quarters, meaning the U.S. has been, and currently is, in a recession.

So the economy is certainly “going through a very difficult period” as Ben Bernanke stated, and he thinks that if he can stimulate the economy, he can raise the RGDP, bringing the economy out its current slump. The Fed expects to return the economy to its long term growth rate in 2009, insinuating that this is just regular cyclical recession, and that the trend line is still pointed upward. But in light of recent events “the uncertainty is quite high and the risks remain to the downside” (Bernanke). The market apparently knew this because treasury notes and stocks hardly changed after what Bernanke said. It seems that the Fed is “surprised that the economy has slowed so quickly” (Silvia), which could also add to the lurching of the economy. To combat this recession, the Fed has taken some recent action. The first actions were to lower interest rates by .75% and back the take-over of Bear Stearns. This lowering of the Federal Funds Rate and coincidental takeover of Stearns is just one example of the Fed influencing the economy. The Fed lowers the interest rate, and then covers Stearns bankruptcy in the interest of the economy and now Stearns is more able to borrow money because of the lower interest rate. Of this, Bernanke says he feels “relatively confident” that the entire principal and some interest will be recovered, making it sound like Stearns’ default risk might be more than what the economy needs.

A few weeks later and further measures have been taken to try and remedy the incoming recession. The central bank opened lending directly to Wall Street Investment banks and securities firms, and at the same time lowered the discount rate a quarter point. So the Fed lowered the rate that it was going to charge these new investment banks and firms in order to make them more likely to take loans, again further increasing the money supply.

Two days after the Discount Rate decrease, the Federal Open Market Committee lowered the lending rate to 2.25%. The FFR is usually around 1% lower than the Discount Rate, even though the FFR is only a quarter percent lower currently. The FOMC is also worried that economy has additionally weakened and officials are concerned about inflation. Apparently this reduction was smaller than traders anticipated, and is due in part to two policy makers that wanted “less aggressive action”. This means that the market was surprised, further causing markets to lag, and that there might be some people who know something about economics. If these men were to have any real impact on the FFR, we might infer that these men were either part of the board of governors or that they were fed chairmen. These men realized that lowering the FFR is not the way to really begin recovery. They have a lower TPR and longer Time Horizon, and realize that inflation is going to be a serious concern in the longer run.

Now, the FOMC is not actually able to set new rates. Only the banks can set their own FFR, but the of course, the FOMC has plenty to do with it. The Fed sets a target FFR, and then the FOMC buys securities and bonds from civilians through Open Market Operations. This injects the Fed’s made-up money into the economy. Now that the economy has more money, they are probably saving more in banks, increasing the amount of money that banks have on hand. The banks still have to pay interest on savings accounts, CDs, and such, so they must find ways to lend that money out to produce income. Banks usually gravitate toward the Fed set