Marty Feldstein on the Current Macroeconomic Situation
He writes:
Our Economic Dilemma: The sharp reduction in the federal funds interest rate and the new fiscal stimulus package may, of course, be enough to avert a downturn.... If a recession does occur, it could last longer and be more painful than the past several downturns because of differences in its origin and character.... [P]ast recessions were caused by deliberate Federal Reserve policy aimed at reversing a rise in inflation....
In contrast, the real interest rate in 2006 and 2007 stayed at a relatively low level of less than 3%. A key cause of the present slowdown... was... the bursting of the house-price bubble.... The Fed therefore will not be able to end the recession as it did previous ones by turning off a tight monetary policy....
[T]he principle cause for concern today is the paralysis of the credit markets.... The dysfunctional character of the credit markets means that a Fed policy of reducing interest rates cannot be as effective in stimulating the economy.... Because market participants now lack confidence in asset prices, they are unwilling to buy existing assets, thus preventing current asset owners from providing credit to new borrowers....
It is not clear what can bring back the confidence in asset prices that is needed for credit to flow again. Some analysts suggest that confidence would return if the financial institutions declare the true market value of their assets by restating balance sheets.... The current situation has the elements of a Catch-22: The credit flows needed for economic expansion require confidence in the values of existing financial assets, but market participants may not have such confidence while the risk of recession hangs over us....
The Fed's bank examinations are supposed to assess the adequacy of each bank's capital and the quality of its assets. The Fed declared that the banks had adequate capital because it gave far too little weight to their massive off balance-sheet positions -- the structured investment vehicles (SIVs), conduits and credit line obligations -- that the banks have now been forced to bring onto their balance sheets....
The implication of this for Fed supervision policy is clear. The way out of the current crisis of confidence is not. We can only hope that those who predict nothing worse than a temporary slowdown are correct.
