You Call This a Recession?

At this time, we expect a Federal Reserve rate cut next on Jan. 30 followed by a March cut, bringing the federal funds rate down to 2.5%. If the fourth-quarter, gross domestic product (GDP) data, due Jan. 30, and the durable orders data (Jan. 29) look good, the Fed may decide not to move next week. However, we would still expect to end up at 2.5%, just one meeting later.

The problem with monetary policy is the lag. We believe the emergency rate cut was a confession by the Fed that they are behind the curve, and are trying to catch up. The timing surprised us; we had expected a 75-basis-point cut at the meeting on Jan. 30. The meltdown in world stock markets Monday, which continued into Tuesday in Asia, convinced them to move quickly to short circuit the collapse. The tactic appeared to work, as stock indices recovered from overnight lows in the futures market and soared during the afternoon of Jan. 23.

But even with this earlier action, the impact on the real economy comes only after a lag of about nine months. In other words, what the Fed did this week will likely help the economy in October, after the recession will be over. The cuts did help stop the stock market slide, and can make the recession shorter and shallower, but, in our view, it is too late for monetary policy to prevent the recession.

STIMULATING THE ECONOMY: CONGRESS

Fiscal policy operates with a much shorter lag — at least ignoring the lag in implementing it. Normally, the problem with fiscal policy is that by the time the government is aware there is a problem, proposes action, and then gets a program through Congress, the recession is usually over.

Historically, fiscal policy has usually been counterproductive, because the stimulus gets applied only while the economy is already in a strong recovery mode. The major exception was 2001, where the stimulus was largely accidental as a result of the 2001 tax cuts, but hit during the summer, when it was most needed.

This time, it may actually get done fast enough. The House leadership and the Administration have agreed quickly on a $150 billion package of tax cuts, including roughly $100 billion in tax rebates and $50 billion in investment incentives for business. Unless the Senate delays the passage, we would expect this to get through by mid-February.

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