Harvard’s Feldstein: US at 33% Chance of Recession and Fed Can't Help

Friday, 08 Jun 2012 11:10 AM

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The chances of the U.S. falling back into recession stand about one-in-three and more stimulus from the Federal Reserve won't do much good either, says Martin Feldstein, a Harvard economist and head of the Council of Economic Advisers under President Ronald Reagan.

In May, the economy added a net 69,000 jobs, far less than expected, while gross domestic product (GDP) grew 1.9 percent in the first quarter, down from a initial estimate of 2.2 percent.

Will the country slide back into a recession?

Editor's Note: Startling Proof of the End of America’s Middle Class. Details in the Video

"You can't rule it out. The economy is weak, weaker than many of the forecasters have been saying. We had less than 2 percent growth in the first quarter and roughly 1.5 percent last year. I think we'll be lucky if we have 2 percent growth in the rest of this year," Feldstein tells Reuters.

"At this point I would say one chance in three, or maybe less than that."

Market talk is abuzz the Federal Reserve will stimulate the economy by purchasing bonds held by banks, a policy tool known as quantitative easing (QE) that floods the economy with liquidity and pushes long-term interest rates down to encourage investment and hiring.

The Fed has rolled out two such measures so far, injecting $2.3 trillion worth of expansionary liquidity into the economy in the process.

The Fed has also shuffled its Treasury holdings in way to better ensure long-term interest rates such as mortgages stay low, a move known dubbed by Wall Street as Operation Twist.

More action by the Fed won't work, Feldstein says.

Rates are already low, the economy brimming with liquidity but demand still remains soft and hiring at bay.

"My sense is that further easing, whether it's QE or Operation Twist, whether it's helpful to the long-term bond market, whether it's helpful to the stock market, it really hasn't done anything for actual economic activity."

Addressing spending and tax reforms will help the economy.

"That's going to require fiscal reforms, and we're not going to see that until after the elections," Feldstein says.

Turning to Europe, the debt crisis there does pose a threat to the United States in that exports to the continent may suffer, especially considering that once red-hot Asian economies are cooling.

"It's significant, because it affects our financial markets and it affects our exports. Exports played an important part in the GDP growth in the beginning of the year, and this will clearly be a drag together with what's happening in China and elsewhere in Asia. That's further reason why the economy will have a hard time getting up to 2 percent GDP growth."

While events abroad are crimping growth at home, so are President Barack Obama's policies marked by increased government spending and regulation, though the president would prefer to cast blame elsewhere.

"It allows the president to say it's not his policies, it's Europe, it's Republicans. But the truth is that the policies of the last three-plus years have not boosted this economy and have discouraged both businesses and potential consumer spenders."

Meanwhile, talk of a coordinated response among the world's top 20 economies, known as the G-20, won't ease the European debt crisis either.

The problem is not uniform, as a recipe for recovery in Greece won't work in Spain or Italy.

"On something like this, when you need different policies for Greece, for Spain, for the United States, that's not something that's going to get worked out in a G-7 or G-20 meeting."

Let Greece exit the eurozone, but do work to keep Spain and Italy in, Feldstein recommends.

A Greek exit will be messy, but after a few years, the country will be better off.

"I think that it will be painful in the short run, but Greece has been going through a very painful process for several years now, with falling GDP and rising unemployment," Feldstein says.

"I think after they go through a couple of years of adjustment, a new drachma, devaluation will drive Greek consumers to spend more at home and spend less on imports and that will start to boost the economy of Greece."

Fed officials will gather at a June 19-20 meeting to discuss monetary policy, though some senior policy officials have already said intervention may be needed.

"I am convinced that scope remains for the FOMC to provide further policy accommodation either through its forward guidance or through additional balance-sheet actions," Federal Reserve Vice Chair Janet Yellen says in prepared remarks delivered at the Boston Economic Club Dinner.

"There are a number of significant downside risks to the economic outlook, and hence it may well be appropriate to insure against adverse shocks that could push the economy into territory where a self-reinforcing downward spiral of economic weakness would be difficult to arrest," Yellen adds.

Editor's Note: Startling Proof of the End of America’s Middle Class. Details in the Video



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