Banking, recession, economy, oh my!

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High hopes and positive thoughts of the global economy turning around are on our minds daily. With doom and gloom being reported, will times ever return to a high employment rate and global financial stability?

We all have questions and look to the experts for answers about the economic outlook. We asked Tara M. Sinclair, Ph.D., associate professor of economics and international affairs at The George Washington University to offer her ideas from research and share her findings.

Given the European debt issues and slower global growth, what is your short-term dollar forecast?

Honestly, if I had a good short-term dollar forecast I’d be betting on it in the markets, but there’s a lot of complexity here that makes things complicated. On the one hand, the U.S. economy is looking weak, but the European economy is looking worse. I don’t see where people can go if they move out of the dollar, but I don’t see a substantial strengthening of the dollar either.

Over the long term, do the poor U.S. fiscal fundamentals eventually catch up with the dollar? If so, over what period of time do you expect this to be the case?

It’s reasonable to expect the dollar to weaken over the long term, but what that time frame is depends critically on the events in Europe, Japan and China. Right now, there’s a lot of uncertainty about what the world is going to look like over the next five years.

Is Operation Twist the most effective step the Fed could put into play at this point? How effective do you expect it to be?

Economic research suggests that Operation Twist could lower long-term interest rates by about the same amount as lowering the federal funds rate (the typical monetary policy tool in the U.S. that right now is basically stuck at its lower bound of zero) by about 75 basis points. That’s not a small policy move, since the Fed tends to move in 25-basis-point increments, but when we’re facing an unemployment rate about 9 percent, it’s not very big, either.

Are there any additional or preferable steps the Fed can or should take to jump-start the economy?

I would rather see more dramatic policy — like a large government bond purchase by the Fed (expanding their balance sheets rather than “twisting”). We should also be more concerned about the health of our banking system — that problem hasn’t been fixed yet. We’ve already moved to punishing the banks for past transgressions, but they aren’t back to health yet, so we could easily, particularly with further problems coming from Europe, have a second wave of the financial crisis.

What are the odds of a second recession later this year or in 2012?

This depends critically on what happens in Europe. If they do not fully address what is going on in Greece and reduce the uncertainty there, then I would predict another recession starting within the next year. Otherwise, we will probably continue in our very slow recovery while households slowly pay down their debts.

We would like to thank Tara M. Sinclair, Ph.D., associate professor of economics and international affairs at The George Washington University for her insight into the global economy. Questions contributed by Greg McBride, CFA, senior financial analyst for