Is Obama Talking Down the Economy?

Karen Dynan
Karen Dynan
Karen Dynan Professor of the Practice of Economics - Harvard University, Nonresident Senior Fellow - Peterson Institute for International Economics

November 8, 2010

Given the substantial headwinds facing the economy, it is hard to believe that we are in for anything but a slow recovery. Parts of the financial system continue to be troubled, housing is still in substantial oversupply, and consumers need to do further deleveraging and saving in order to rebuild the wealth they lost through falling home and equity values. All told, the president’s pessimism seems well-founded, as it will probably be years, if not a decade, until we are back to full employment.

The Fed does not have the power to cure our economic woes overnight, but its decision to revive its quantitative easing program should help hasten the recovery. The available evidence suggests that although the second wave of the QE program may not have the same bang for the buck as the first, it should at least provide some boost to household and business spending by reducing long-term interest rates and easing financial conditions more broadly.

Critics warn that the Fed’s new policy puts us at risk of rapidly rising inflation once the economy does start to recover. But, such an outcome seems unlikely, as the Fed has already detailed its plan for unwinding the stimulus when the time comes. Moreover, the risk of doing nothing is substantial. Core inflation has fallen to its lowest level in decades, and worries are building that, without more stimulus, we will eventually see deflation. This would just intensify pressures on already struggling borrowers as they find they have to meet future debt obligations in dollars that are becoming more valuable over time. The recovery would be slowed further, and we could even perhaps slip into a Japanese-style economic stagnation.