In the last few months, some have taken to calling the current economic period, “the Lesser Depression” (instead of “the Great Recession”). There’s no precise definition of “a depression” (and as it is, the definition of “a recession” is rather vague). Most economists would say a depression is a lengthy period of elevated unemployment. That’s exactly what we may be staring out now. Monetary and fiscal policy could provide further support for growth, but there’s a lot of resistance.

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Weekly Commentary by Dr. Scott Brown
Policy Conundrums
August 29 – September 2, 2011
In the last few months, some have taken to calling the current economic period, “the Lesser Depression”
(instead of “the Great Recession”). There’s no precise definition of “a depression” (and as it is, the definition
of “a recession” is rather vague). Most economists would say a depression is a lengthy period of elevated
unemployment. That’s exactly what we may be staring out now. Monetary and fiscal policy could provide
further support for growth, but there’s a lot of resistance.

2. Bernanke’s Jackson Hole speech shed a little light into the August 9 FOMC policy meeting. Not surprisingly,
the Federal Open Market Committee “marked down its outlook for the likely pace of growth over coming
quarters.” Policymakers generally felt that inflation would “settle” at or below 2%, the upper end of the Fed’s
comfort range. The inflation outlook, along with expectations of continued excess capacity in production and
labor, allowed the Fed to be more explicit about the time period for which short-term interest rates are
expected to remain exceptionally low (“through the middle of 2013”).
Short-term measures of core inflation have been trending higher in recent months. Some of this may be
related to the pass-through of higher commodity prices. Commodity prices have generally fallen recently and
the Fed apparently expects that low rates of resource utilization will put downward pressure on consumer
prices. This outlook gives the Fed more leeway to act, but not every member of the Federal Open Market
Committee agrees with that assessment.
Bernanke indicated that the Fed considered alternative tools to support growth at the August 9 FOMC
meeting and would continue to do so at the September 20-21 meeting (which has now been expanded to two
days). The economic data releases for the next two weeks will be critical for the Fed’s decision.

3. The Fed still has some tools in its kit. However, fiscal policy could do a lot more of the heavy lifting right now.
Unfortunately, “stimulus” is a dirty word in Washington.
As a whole, Americans are frustrated with the current size of the federal budget deficit and without a doubt,
we are on an unsustainable trajectory. The budget deficit can be reduced over time, but people aren’t going to
like how we get there (higher taxes and sharp cuts in discretionary spending). However, reducing the deficit
too soon risks damaging the economic recovery. It may be counter intuitive to most people, but the federal
government should loosen fiscal policy in the short term and tighten more significantly later on.
ARRA (the American Recovery and Reinvestment Act of 2009) has been criticized from both sides. Some
said it shouldn’t have been done – that it would significantly raise the government’s borrowing costs. Well,
the 10-year Treasury yield is currently below 2.20%. Others said it wasn’t large enough and was poorly
structured. A third of the stimulus was aid to the states. Less than a fifth was infrastructure spending. For the
most part, the stimulus prevented the economy from weakening a lot more. It acted like a bridge (providing
public-sector support while the private-sector recovers), but the bridge wasn’t long enough.
In a week or so, President Obama will announce proposals to boost job growth and shore up the housing
sector. These efforts, even if they could make it through Congress, would help somewhat, but wouldn’t boost
economic growth substantially.
Bernanke’s Jackson Hole speech showed that the Fed chairman remains optimistic about the long-term
prospects for the economy. Current difficulties are unlikely to affect the long-term growth potential, but he
stressed that is “if our country takes the necessary steps to secure that outcome.”