As the US seems to be shaking off the recession, most are wondering what will the new order of the day be and how will the business market react. The first step in understanding this would be to take a position on where you feel the short term outlook for the economic health of the country. To this end, I have the conclusion of the paper written by my team (Sue Strebol, Scott Campbell and myself) in our Intenational Macroeconomics class on our predictions for December 2010.
Overall we believe the recession is past and the turnaround has begun. The economy is at a crucial time when over reactions and no reactions could cause a double dip in the recovery. Bernanke appears to be particularly mindful of this and is acting conservatively by gradually increasing the gap between the discount rate and the federal funds rate. As the banks continue to increase their interbank lending and decrease their borrowing from the Fed, the gap between the discount rate and the federal funds rate should be increased to the full 100 basis points it was prior to the financial crisis by June 2010.
There will still be some banks closures from residual fallout of the financial crisis but overall the banking system is stabilizing. The Fed and Congress need to not over react with new regulations or an overhaul of current system but take a serious look at what works and what doesn’t. The ability of financial institutions to operate as both an investment bank and a commercial bank may need to be re-separated with another Glass Steagall Act. The derivatives market should also adhere to standards through enforceable regulations regardless of who issues them or how they are sold.
The exchange rate is market dependent and while the Euro zone is dealing with their crisis the U.S. dollar will remain strong. The U.S. needs to pay back some the foreign debt it borrowed to finance the bailout. Most of the money that was lent to the major banks to maintain liquidity during the crisis has been paid back to the government so rather than spend these funds on additional programs; the U.S. should pay down its debt. This would not only show that the U.S. is serious about lowering its debt and keeping it comfortably below 60% of GDP but also while the US dollar is strong the payments would go much further.
It will take time for the economy to completely turn around but if efforts through monetary and fiscal policy are rushed they could cause instability and the economy would slip back down causing an even longer recovery period. The main driver is consumer confidence. Once consumers feel the worse is past and return to normal consumption, then the economy with once again grow steadily. The Dow Jones has show steady growth since its low point in early 2009 indicating the market is rebounding and is expected to be at approximately 11,900 by year end.
