Economic Forecast Updated January 2009

The worst part of this forecast update is history. The fourth quarter is still a forecast, because we won't have official GDP data for another couple of weeks, but the monthly numbers we have are looking worse and worse. As I mentioned recently, exports, are diving. Then we got worse-than-expected news on December retail sales. We knew it would be bad, but not quite this bad.

Looking forward, we still have a lot of monetary stimulus in the pipeline. In my book, I described a very reliable phenomenon. When the Fed starts to stimulate the economy through monetary policy, there will be an article in the New York Times or the Wall Street Journal (or both!) saying that monetary policy no longer works. There will be no mention in the article about time lags. Then the Fed's actions will kick in, surprising the pessimists. We'll also see consumers kick in, as I mentioned in a video, as implied by the charts in a prior post.

So here's my economic outlook:

The early quarters of recovery are sub-par. We will not have the usual make-up-for-lost-growth experience, because the economy's usual "low gear" is housing construction. The overhang of excess supply will dampen new construction. The key turnaround will be in consumer discretionary spending. I think the fiscal stimulus package will occur too late to trigger the turnaround. After the economy gets going, the public works elements of the stimulus package may offset reductions in defense spending.

If I'm right, then late 2009, or early 2010, the Fed will either raise interest rates sharply, or let inflation accelerate. I believe they'll raise rates, but one of my respected colleagues makes a strong argument that the Fed won't raise rates, they'll let inflation get going. That's a real risk, but I'm sticking with higher interest rates as the more likely event.

I know plenty of folks can't believe that this recession will end soon. Let me note first that my forecast isn't very optimistic, because of the lackluster recovery.

Second, behavioral finance research has confirmed "recency bias." People tend to overweight recent information. I think that's part of the doom-and-gloom mood right now. People are forgetting that we always get over recessions.

Economy

Economic Forecast Updated January 2009

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