2010s a ‘lost decade’ or a temporary funk?
The dramatic economic slowdown this summer has provoked an increasingly contentious debate among analysts, including an unusually public split among members of the Federal Reserve Board, over the U.S. economy’s long-term outlook and the possibility of a Japan-like “lost decade.”
The Fed’s gloomy assessment this week, combined with a spate of poor U.S. economic numbers, is raising the stakes in the escalating argument between top economic thinkers fearful that the nation is headed for a decade of decline and stagnation versus those who think it’s a temporary funk driven by businesses and consumers grappling with uncertainty from a deluge of regulatory and tax changes.
Both views are being bandied about not only in Congress‘ heated fights over stimulus legislation but in the cloistered halls of the Federal Reserve, where officials met earlier this week and made clear that they fear a further slowdown. In their statement, the Fed members declared that the recovery’s pace “has slowed in recent months” and is “likely to be more modest in the near term than had been anticipated.”
On Wednesday, all three major indexes reacted to the bad Fed assessment and recent statistics, losing more than 2 percent of their value. The Dow Jones industrial average was down 265.42 points to close at 10,378.83, the Standard & Poor’s 500 index fell 31.59 points and finished at 1,089.47, and the Nasdaq composite index lost 68.54 points and ended the day at 2,208.63.
The unusually acrimonious debate within the Fed about the chance of a lengthy deflationary spiral broke into the open at the end of last month when James Bullard, president and chief executive officer at the Federal Reserve Bank of St. Louis, touted a white paper ominously titled “Seven Faces of the Peril.”
It posited that the weakening economy is closer than it has ever been to a Japanese-style period of stagnation and deflation, often dubbed the “lost decade” of growth, although in Japan it has spanned closer to two decades.
According to Mr. Bullard’s analysis, official measures of inflation in the United States have fallen to about 1 percent and are expected to decline further - entering what economists consider a deflation danger zone where consumers and businesses could trigger a destructive downward spiral in the economy by putting off purchases as they await lower prices. This last happened in the United States during the Great Depression.
Mr. Bullard said a repeat of that economic nightmare is unlikely but that the Fed’s low-interest rates policies - it has held short-term rates close to zero for nearly two years - could be contributing to deflationary psychology. The Fed must be ready to counteract another economic plunge through unconventional measures such as purchasing government bonds, he said.
Indeed, that’s what the Fed did, saying Tuesday that it would start buying government debt in a bid to lower interest rates, boost borrowing and stimulate the economy. On Wednesday, it announced an $18 billion purchase to run from Aug. 17 to Sept. 13.
As for the prospect of an extended Japanese-style stagnation period, Richard W. Fisher, president and CEO of the Federal Reserve Bank of Dallas, dismissed Mr. Bullard’s broad argument. He said there’s nothing wrong with the economy that couldn’t be overcome by clearer and more rational fiscal and regulatory policies from Washington.
Businesses and consumers are not spending and making plans as usual because of large tax increases looming at the end of the year while Washington is moving to increase the cost of nearly everything else from health care to energy and credit, he said.
In internal Fed meetings, “I have ascribed the economys slow-growth pathology to what I call ‘random refereeing’ - the current predilection of government to rewrite the rules in the middle of the game of recovery,” he said in a July 30 speech to the San Antonio Chamber of Commerce. The recently enacted financial reform bill is a prime example of that, he said.
Mr. Fisher cataloged an array of outstanding questions whose resolutions could affect nearly every citizen, including what to do with President George W. Bush’s expiring tax cuts at the end of the year and whether baby boomers and future generations can expect scheduled Social Security and Medicare benefits or lose some of them as Congress moves to tame out-of-control deficits.
“In a tumultuous economic climate accompanied by extraordinary economic and political divisions, it is perhaps unsurprising that there is no consensus on even what the general thrust of fiscal policy should be, let alone which specific provisions should be adopted,” Mr. Fisher said. But businesses and consumers need to know before they can make major decisions.
Meanwhile, major industries - including energy, banking and health care - are being confronted with radical new regulatory and tax regimes that make it unclear how they will do business in the future - or even whether they can stay in business, he said.
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