Today"s Topic:Economic Short Cycles
It seems recently that economic news is moving in short cycles. Recent reports, other than bank earnings, are negative. A survey of manufacturers indicates that this sector will continue to decline another 3-6 months and that federal stimulus spending will only be marginally effective. The Fed announced that its own index of industrial production is down 15% over the last year. By comparison, the decline in the 2001 recession was 6.8% as tabulated by the WSJ (Wall Street Journal). In addition, retail sales were down for March, after two months of improvement. Since consumption is about 70% of AD (aggregate demand), this does not bode well for a quick recovery.

Finally, there was mention of what, in class, we call a recessionary gap, a big shortfall in our current levels of output with our potential level of output. The emphasis was that with low levels of output and high unemployment, deflation, is the order of the day. We are experiencing a small amount of deflation, which so far is not worrisome.

The fear that the Fed has of deflation is that if the recession deepens AD will decline further and deflation will get worse. If this happens and consumers catch on, they may well respond by delaying major purchases to get better prices later. This would worsen the recession. Unfortunately this has happened in Japan a lot since 1990.

I believe the Fed should be able to avoid this, but it may take the bulk of this year to be sure.