The very sharp Gavyn Davies summarizes four views of the macro outlook: Powell/Bernanke/Summers/DeLong. Not sure I belong in this company...
As he sees it, the Fed is now confident that there will neither be inflation which will require it to raise interest rates and trigger a recession nor private-sector weakness which ought to have led the Fed to have already returned the Federal Funds rate to zero. The first seems correct. But I am not sure why the Fed believes in tiger second—and I have no idea what the Fed thinks it can do if the second comes to pass: Gavyn Davies: Recessions and Bear Markets—The Terrible Twins: "Many global markets... are now pricing a probability of recession of at least 50 per cent within 12 months. This recession risk seems far too high.... Inter-relationships between recessions and bear markets are complex and not very well understood. It is clear that they tend broadly to coincide in their timing.... Economists often assume that recessions are basically caused by economic fundamentals, with the financial markets reacting when these fundamentals deteriorate. Sometimes investors may be able to discern rising recession risks before they actually appear in hard economic data...
...However, in recent cycles, leverage in the financial system has generated such large gyrations in asset prices, liquidity provision and risk appetite that it has independently caused recessions in the real economy.... Claudio Borio... has argued persuasively that, since the mid 1980s, the financial cycle has operated with a much longer amplitude than the economic cycle, and that it has predicted the onset of economic recessions.... Fortunately, the current state of the financial cycle is not pointing to severe vulnerabilities in the US and other advanced economies.... The leadership of the Fed is optimistic that the US economy will slow this year, but that recession risks are low, because the labour market, corporate finances and financial imbalances in the private sector remain in good shape.... Ben Bernanke recently argued that economic expansions... are murdered, presumably by the central bank... tightening in monetary policy.... A more pessimistic assessment... Lawrence Summers... a recession is at least 50 per cent likely in the next year or two... a spontaneous slowdown in aggregate demand... Chinese slowdown... a failure of the US fiscal authorities to prepare infrastructure programmes in advance to stabilise demand. On this view, recent financial turbulence is correctly anticipating, not causing, a weakening economy.
A different view is that financial instability will be sufficient on its own to cause the next recession. Brad DeLong argues that only one of the past four recessions (in 1979-82) was “conventionally” caused by a hostile Fed, while the other three were directly caused by instability in the financial system. While the specific trigger for the next downturn is inherently unpredictable, he thinks the culprit will be a sudden, sharp “flight to safety” after the revelation of a fundamental (but unexpected) weakness in financial markets. That, says DeLong, is the main factor that has been generating downturns since at least 1825....
In my opinion, the optimists probably have the weight of evidence on their side for now, especially since the Fed has revealed its true, dovish colours..
#noted
