Baseline
Forecast Overview

Demand Side has forecast more negatively than most over the past twelve months, and we continue that looking forward. Our view is that a downward spiral, a self-reinforcing feedback loop, is now baked into the next six months. We expect policy changes with the advent of the new Obama administration, but these will come too late to avoid significant damage to the financial sector and the real economy.

Assumptions:

Summary: The scale of stabilization, stimulus and recovery activities will lag behind the need for them for some time. The scale of response to the financial sector's continuing collapse, the severe economic recession, the problems of climate change and global poverty will be far short of what is needed. Fiscal action on the order of $3.5 trillion is the scale that can make a return to prosperity possible. Action is likely only in the range of $600 billion to $1.2 trillion.

Current Context

Real household wealth ihas collapsed from the collapse of home prices, the fall in the stock market, and the blow to incomes from the commodities bubble (including $140 oil) of the first part of 2008. Employment continues to fall month after month. Corporate profits are considered positive news if the losses are less than the Street's estimates.

The Federal Reserve has prosecuted an aggressive policy of creating liquidity targeted at saving the current banking institutions. This policy has failed, both to save these institutions and to prevent the dreaded deflation.

Professional economists are finally on board with the recession call, which may indicate we are closer to the end than to the beginning.

1. The housing bubble that collapsed in 2007 left the nation in recession.


2. Consumer weakness and the subsequent collapse of the financial sector has led to a freeze in international trade, in short-term lending necessary for business operations, and in consumer lending across the board.


3. We factor in the intention announced by the Obama transition team to produce 2.5 million new jobs in the administration's first two years through programs in green energy and infrastructure.


4. We expect significant progress on health care reform to be in place by 2011.


5. We expect an aggressive program to stabilize foreclosures that will put a floor under housing prices and keep the housing market from falling through its correction level. That level is about 40 percent below the peak market level, however, and housing will not return to its bubble dimensions, nor will it lead an economic recovery


6. We expect no recovery in consumption for at least two years. Consumers are, in Nouriel Roubini's terms, "shopped out, saving less and debt burdened." In the process of recovering their balance sheets, consumers will need to practice a frugality that will make them no longer the reliable engine of growth.


7. We expect dramatic growth in the federal deficit and debt for the first two years of an Obama administration, and eventual recovery will be hindered by this debt and a probable explosion in debt service that would accompany any recovery.


8. We factor in only a slight improvement in international economic coordination and trade.


9. We expect a somewhat more pronounced improvement in international cooperation on global warming and global poverty.

Growth

GDP numbers are notoriously unrealiable. We use two measures: Real GDP, which corresponds to the official number tracked by virtually all economic observers, and Net Real GDP, which subtracts borrowing by the federal government, which is essentially the fiscal stimulus necessary to produce the Real GDP number. As we've repeatedly suggested, it makes little sense to count as a product of the pump the water needed to prime it.

Real GDP will suffer mightily in 2008 Q4 and 2009 Q1 as a result of the self-reinforcing feedback of consumer weakness into the banking sector and back into consumer weakness. This downturn is emphasized by the September 2008 crumbling of the banking system in spite of Federal Reserve efforts to patch it up.

Inflation

The inflation of the commodities bubble has given way to the deflation of the collapse in effective demand.

Demand Side was way ahead on inflation, as we -- along with the average American -- saw energy and food stampeding toward us. Nine months ago our inflation figures were far above everyone else's. Three months ago they were right on the mark. Now we have the September 2008 financial sector collapse and amplified weakness in demand across the board. This will usher in a period of deflation corresponding to stagnation that will not recede until the underlying problems with aggregate demand are addressed by public sector action.

Headline Inflation

Collapse in commodity prices and aggregate demand will hit commodities producers, both within and outside the U.S., very hard. This will be another avenue of negative feedback further contributing to weakness and recession

Core Inflation

Core inflation will be weaker than headline inflation because the enormous slack in the labor market, projected double digit unemployment, will force wages and salaries down. Labor is the primary component of core inflation.

Employment and Unemployment

The baseline scenario for employment and unemployment is significantly below that of other economists as represented by the Philadelphia Fed's survey of professional economists and the quarterly projections of the Federal Reserve Open Market Committee.

Unemployment

Workers without jobs have increased dramatically in the past three months, and we expect this acceleration to continue through 2009 Q2, producing a jobless rate not seen since the early 1980s. The experience of the labor force is actually more severe than this number suggests, and ought to be half again higher. Adjustments to the unemployment metric since the early 1990s make it less descriptive than in earlier years.

Employment

Demand Side expects George W. Bush to come within one million of being the first president in postwar history to preside over an economy that produced no -- zero -- net new jobs. Add to this the deteriorating quality of jobs and the deep hole in which we find ourselves becomes increasingly clear.