Economists have debated the possibility of a double-dip recession ever since the economy went into a free-fall more than two years ago. One opinion is that waiting to tackle the deficit could result in a bond market crisis. That would spur a double-dip recession, according to former Federal Reserve Chairman Alan Greenspan in an interview on “Meet the Press” in mid-November.
“We have to resolve this issue before it gets forced upon us,” said Greenspan. His fear is that the long-term deficit could “spook” the bond market “to a point where long-term interest and mortgage rates move up very sharply. If that happens, that will cause the double-dip.”
Current Fed Chairman Ben Bernanke also lowered projections for the 2011 economic outlook, with forecasts of a slow economy and only gradual improvement in the job market.
Still, both economists say a double-dip recession is unlikely, as recent signs show the economy is slowly recovering, along with the economies of other countries.
The Fed’s plans
The effects of the Federal Reserve’s plans for additional “quantitative easing”—purchasing $600 billion in long-term Treasuries through midyear 2011, and reinvesting an additional $250 billion to $300 billion in Treasuries—are still largely unknown, says Mike Schenk, vice president, economics and statistics, for the Credit Union National Association (CUNA).
Quantitative easing could have negative and positive effects on the economy, he says. While it “increases the money supply by flooding financial institutions with capital to promote increased lending and liquidity,” he says, “the major risk is that it could eventually lead to higher prices and inflation.”
The potential effects of quantitative easing, says Schenk, include:
• Potential increases in lending, spending, and growth. But since households remain overextended with debt, it’s unlikely to stimulate significant amounts of consumer borrowing.
• Lower long-term interest rates might cause more mortgage refinancing, leaving households with more income to spend on other things.
• Lower interest rates should soften the blow of adjustable-rate mortgage adjustments—increasing discretionary income and lowering the risk of additional foreclosure activity.
• Lower interest rates should encourage businesses to make more capital investments, which would boost economic activity and lead to future productivity gains.
• Increased risks of inflation and hyperinflation.
• The risk that expectations have changed. In other words, quantitative easing might cause some housing market activity to stall, since people might be expecting even lower rates sometime in 2011.
“Quantitative easing isn’t necessarily all good,” says Schenk. “It results in changes in behavior and expectations, and this can be a problem from an economic perspective.”