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Fed Believes It Can Prevent A Deep Recession

Apr 23, 2008
Despite the IMF ( International Monetary Fund ) saying the US would suffer a recession this year, recovery would not begin until next year and growth would remain well below trend even in 2009, the Fed believes that it can avoid a serious slump similar to the Japanese recession in the 1990's because U.S. policymakers will do whatever it takes to avert such an outcome.

The U.S. central bank's willingness to employ unorthodox measures is reflected in its latest supersized liquidity operations, which involved lending financial institutions $436bn in one-month advances of cash and Treasuries.

The Fed has also begun to put public pressure on lenders to recapitalise and take writedowns on loans, while supporting policy initiatives to ease loan restructuring and support financing of new homes through the Federal Housing Administration.

The Fed's move came amid growing concern that there's a real risk that the U.S. downturn could turn into a deep and protracted recession, prompting experts to ponder what might be needed to avert such an outcome.

Following the grim job reports of February and March, most economists believe that the U.S. is now in a recession and the economic debate is shifting to how deep and long it will be. Until recently, the mainstream opinion was that any recession would be mild, because of strong global growth, Fed rate cuts and the $168bn fiscal injection.

But a darker view has taken hold as the labour market has started to crack, house price declines have intensified and financial markets have deteriorated further. Economists worry that consumers are overextended and could start pulling back.

Some analysts even expect a double-dip recession, with growth fading again after a short-lived boost from the fiscal stimulus around mid-year. This bleak view is reflected in financial markets, where the return on five-year Treasury inflation-protected securities is slightly negative - suggesting that investors believe the Fed will not be able to run positive real interest rates on average for five years.

There's a deep concern that banks are pulling back on capital at risk, drawing liquidity out of the markets and triggering contagion at hedge funds. This has caused fresh turmoil in the market for mortgage-backed securities, intensifying the pressure on housing.

Here you have 3 vicious cycles going on simultaneously according to Lawrence Summers, a former U.S. Treasury secretary.

1. A liquidity vicious cycle - in which asset prices fall, people sell and therefore prices fall even more.

2. A Keynesian vicious cycle - where people's income go down and they will start spending less, and so the income of other people goes down as well and they will start spending less too. It's like a chain reaction or domino effect.

3. A credit accelerator - where economic losses cause financial problems that cause more real economic problems. A chain reaction again!

Fed officials insist that the U.S. will not end up like Japan. Not because economists could not possibly deliver such an outcome, but because the U.S. system will not allow problems to fester, and policymakers will take whatever steps necessary to avoid a Japan-style recession.

Good and Successful Trading!

Ricky Schmidt
About the Author
Ricky Schmidt's website http://www.stockbreakthroughs.com was created out of frustration in trying to decode books, magazines and newsletters on the subject, which are supposed to be for beginners but are not because they're too difficult to understand. Too many "Big Words" and too much intelligent sounding grammar is used which is not very useful.
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