The U.S. economy is treading water, trying to keep afloat and weighing options as we head into 2012. Hard work and savvy finance by the Federal Reserve to keep interest rates low might have helped, if it hadn't been for the extra burden of worldwide crises such as the European debt crisis, the Japanese earthquake and political problems in the Middle East. With high unemployment rates and a potential double-dip recession on the horizon, what's a country to do?
We spoke with Tim Duy, Ph.D., director of the Oregon Economic Forum and assistant professor of undergraduate studies in the Department of Economics at the University of Oregon, and asked his opinion on the current market and whether the Fed should initiate QE3 to help bring the U.S. back to life. Professor Duy has worked as an economist for the United States Department of Treasury. He has also worked with the G7 group, which is seven leading nations that discuss global economic issues. He was responsible for monitoring the activities of the Fed.
Have the odds of a recession in 2012 declined, and if so, what odds would you now put on a recession in 2012?
I still think the odds of a recession in 2012 are better than even. I have not seen anything that alleviates my central concern -- that Europe's financial crisis will only worsen in the months ahead, leaving the U.S. vulnerable to negative trade and financial shocks.
If the Federal Open Market Committee initiates purchases of mortgage-backed securities or another form of quantitative easing, do the pros outweigh the cons?
Yes, I believe the pros outweigh the cons with regard to additional monetary easing. With unemployment near 9 percent, I believe there is limited room for sustained, inflationary dynamics to emerge. Moreover, even if inflation edged higher, I think the costs of slightly higher inflation would be outweighed by the positive benefits of lower unemployment and more rapid GDP growth. Additional MBS (mortgage-backed securities) purchases could be particularly helpful if combined with federal programs to help borrowers with underwater homes refinance into lower-rate mortgages.
Is there anything other than QE3 the Fed can do, or should do, to jump-start the economy?
I think of two additional options. The first is to communicate a willingness to accept higher inflation until the unemployment rate drops to some target such as 7 percent. This is the approach advocated by Chicago Federal Reserve President Charles Evans. Second, I think they would have a greater impact of expectations if the Fed explicitly admitted some of the additions to the money supply are permanent, as opposed to the current situation where the expansion of the balance sheet is explicitly temporary in nature. I believe economic agents are understandably unwilling to act on the additional money created by the balance sheet expansion because they assume it will be reversed.
What one single economic issue isn't getting the attention it should?
So many issues -- do you mean from policymakers or market participants? Policymakers need to be much more concerned with income inequality and unemployment. And, even though I am very cautious about next year, I do wonder if analysts are overly pessimistic about retail sales this holiday season, which would be a near-term upside surprise.
Over the long term, I think we need to consider the consequences if Europe slips into a liquidity trap.
We would like to thank Tim Duy, Ph.D., director of the Oregon Economic Forum and assistant professor of undergraduate studies in the Department of Economics at the University of Oregon, for offering his insights. Questions for this interview were contributed by Greg McBride, CFA, senior financial analyst for Bankrate.com.