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.
So here's my economic outlook:
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.