AUGUST
2011

 

By
Larry DeBoer
 
Professor of
Agricultural Economics
Purdue University

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8-25-11

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Searching for Rosy


The recovery from the Great Recession is faltering. Gross domestic product grew less than 1 percent above inflation in the first half of this year. The unemployment rate remains above 9 percent. Rising oil and food prices helped increase inflation to 3.6 percent over the past year. Consumer confidence is way down. Financial markets are in turmoil - again.

It's not hard to find forecasts for more of the same. For example, the latest Philadelphia Federal Reserve survey of business economists predicted 2012 growth at a tepid 2.6 percent and 2012 unemployment still at 8.6 percent. The August survey was more pessimistic than the one in June.

Probably they're right. It's hard to see why the economy will do better next year than it's doing this year. But let's try. Let's call upon "Rosy Scenario" to find some reasons why businesses might increase their production of goods and services and hire more employees. Businesses expand when they think sales will increase. Sales increase when people increase their demands for goods and services.

Tell us Rosy, what could increase demand?

How about monetary policy, the actions of the Federal Reserve to reduce interest rates and encourage borrowing and investment? At its latest policy meeting the Fed pledged to hold the federal funds interest rate near zero for two more years. Mortgage rates and corporate borrowing rates are near-record lows. And monetary policy usually works with a six-to-12-month lag, so perhaps we haven't yet seen the full impact of the Fed's money supply increases from the first half of this year. Businesses might start borrowing, buying and building, which would increase demand for all sorts of goods and services.

But Rosy, businesses still have unused capacity, so why invest in new plants and equipment? Why build new homes, where there are so many vacant homes for sale at ever-falling prices? Try again, won't you?

OK, how about stability in Europe? Greece, Portugal, Spain and Italy are in danger of defaulting on their government bonds, and this is causing a lot of worry among bankers. Worried bankers lend less. The European Union is trying to come up with a plan to fix this problem. If they do, financial markets will be more confident and lending will increase.

But Rosy, they're having a terrible time coming up with anything concrete. The Germans don't want to foot the bill for a bailout, and the European Central Bank objects to repayment adjustments. We'll probably see more stopgap measures, and confidence won't improve. And if there's an actual default, we could be back in recession in no time. You'll have to do better than that.

How about a drop in oil prices? Libyan oil has been off the market since the rebellion started. Once the rebels win, the markets will expect the supply of oil to increase, and oil prices could drop, a lot and fast. Consumers would have more money to spend, business costs would decrease and we'd all feel a little better about everything.

But Rosy, it may take a long time for a new Libyan government to get production rolling, and OPEC may cut output elsewhere to keep oil prices up. Besides, some of the increase in oil prices comes from growing demand in China. I'm just not buying it.

Well, how about China? The inflation rate in China is 6 percent and rising, and Chinese officials are concerned. One way to attack the problem is to let the value of China's currency rise faster relative to the dollar. Imported goods would be cheaper in China, which would hold down inflation. Chinese demand for U.S. goods would increase, so U.S. businesses would produce more for export.

But Rosy, you know another way China could attack inflation would be to slow its economy with higher interest rates and government spending cuts. That could reduce our exports to China. And any rise in exports is likely to be gradual, not enough to make much of a dent in unemployment anytime soon.

All these rosy scenarios seem unlikely. Probably the economy will continue to struggle. But Rosy's point is, there are some things that could go right. If they do, the economy will improve.

 

Writer: Larry DeBoer,
Editor: Olivia Maddox,