- The Washington Times - Sunday, February 17, 2008


Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson appeared before the Senate Banking Committee Thursday in the wake of reports that (1) home prices fell during 2007 amid predictions that potentially larger declines will occur this year — a development that would make 2007 and 2008 the first time since the Great Depression that home prices decreased two years in a row; (2) the economy experienced a dramatic slowdown in the fourth quarter, growing at an anemic 0.6 percent annual rate (with industrial production actually declining); (3) consumer and producer price inflation significantly accelerated last year; (4) nonfarm employment fell in January for the first time since August 2003; (5) business activity in the nonmanufacturing sector decreased in January for the first time in 58 months; (6) the dollar has entered its seventh consecutive year of decline, as the trillions of dollars slushing around in the coffers of America’s foreign lenders continue to lose their value, aggravating our creditors who have been financing our consumption binge; (7) the S&P; 500 stock index has fallen nearly 15 percent from its October high; and (8) a nasty credit crunch continues to exact its toll across the nation and throughout its financial markets as commercial and investment banks report multibillion-dollar losses linked to the worsening housing and mortgage crises.

Even as economists at Goldman Sachs, Merrill Lynch, Morgan Stanley and elsewhere in the private sector have predicted that a recession has either already begun or will soon commence, Mr. Bernanke and Mr. Paulson reported that their current economic forecasts project that the U.S. economy will avoid a recession in 2008 and continue to grow during the year.

To be sure, the Federal Reserve has been revising its forecasts downward. In June, long after the housing crisis had begun, the Fed projected that the economy would grow between 2.5 percent and 2.75 percent during 2008. In late October, it lowered its growth forecast to a “central tendency” between 1.8 percent and 2.5 percent. At the Banking Committee hearing, Mr. Bernanke said the Fed’s latest forecast, which will be unveiled when the Fed delivers its semiannual monetary policy report to Congress this week, “will show lower projections of growth, and they’ll be reasonably consistent with what we’re seeing with private forecasters.” However, he said that “growth looks to be weak but still positive during the first half of the year,” and he added that the Fed expected “strengthening later in the year.”

The Banking Committee Chairman, Sen. Christopher Dodd, Connecticut Democrat, wanted to know why the Bush administration recently projected an “excessively high” 2008 growth rate of 2.7 percent in its fiscal 2009 budget and in its 2008 Economic Report of the President, which was released Monday. Mr. Paulson replied that the administration decided to stay with its November forecast. He acknowledged the administration “would not have a similar forecast today.” Declining to offer a specific growth rate, he did say he “continue to believe this economy is going to keep growing.”

Mr. Bernanke cautioned that the Fed’s projection was “a baseline, and there are risks to that forecast.” And Mr. Paulson prefaced his updated growth forecast by saying “there are no guarantees.” Indeed, all forecasts carry risk. We can only hope that their crystal balls prove to be accurate, but the growing body of evidence cited above seems to be pointing in the opposite direction.

If January’s worrisome decline in nonfarm employment is followed by more job losses, a very strong recessionary signal will have been sent. History is pretty clear about this. Revised nonfarm employment data, for example, reveal that increasingly large job losses started to occur in August 1981, the month after the deep 16-month 1981-82 recession formally began. Revised payroll data also show that nonfarm employment declined for the first time in several years in July 1991, when an eight-month recession began. Consecutive monthly job losses did not begin until March 2001, according to revised payroll data, and that proved to be the beginning of the eight-month 2001 recession.

The Fed’s crystal ball did not work very well in 2001. In the monetary policy report the Fed delivered to Congress in February 2001, the month before the recession officially began, the Fed projected the economy would grow between 2 percent and 2.5 percent during 2001. In its monetary policy report delivered in July, which later proved to be the midpoint of the 2001 recession, the Fed was still forecasting that growth during 2001 would be between 1.25 percent and 2 percent. Worth noting is that the final forecast of the Clinton administration projected that the economy would grow by 3.2 percent during 2001.

If the economy manages to avoid a recession this year, history will likely record that such good fortune occurred as a result of the Fed’s frantic efforts to mitigate any damage to the real economy from the turmoil that has engulfed the financial markets since last summer. Rightfully spooked by the Labor Department’s initial report in early September that the economy shed jobs in August (revisions subsequently reversed the August job losses), the Fed reacted Sept. 18 by lowering its target short-term interest rate by half a percentage point. Quarter-point reductions ensued in October and December, and over a nine-day period in January, the Fed cut 1.25 percentage points from its target rate, lowering it to 3 percent on Jan. 30. Two days later, the Labor Department reported that January payrolls had declined, setting off a mad rush to predict a recession had begun.

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