Kohn on V-shapes, housing, inflation and a whole lot more

October 13, 2009

Donald Kohn, the Fed’s number 2, has a lot to say about the economic outlook but not a whole lot new in terms of when the central bank will reverse course on its extraordinary easy monetary policy. Full speech at the National Association for Business Economics in St. Louis can be found here.

Some choice bits:

I don’t think a V-shaped recovery is the most likely outcome this time around.

I’m not sure the stock market and credit markets agree, but they might come around to his way of thinking eventually.

The demand for U.S. exports has been increasing lately after falling sharply in the first half of the year. However, with the firming of domestic demand, imports have also begun to increase, and, on net, the external sector appears to be a roughly neutral influence on overall economic activity at present.

There’s been lots of talk about a weak dollar feeding an export-led recovery, but it doesn’t look like it’s weak enough just yet.

And here’s my favorite on the recovery in the housing market. Emphasis mine.

An encouraging aspect of the improvement in economic and financial conditions in recent months has been the firming in house prices that I mentioned earlier. House prices can affect economic activity through several channels. One channel is through the influence of house prices on the net worth of households and, thereby, on consumer spending. Another channel is through the effect of anticipated capital gains or losses from investing in residential real estate on the demand for housing. Finally, greater stability in house prices should help reduce the uncertainty about the value of mortgages and mortgage-related securities held on the balance sheets of banks and other financial institutions, which should have a positive effect on their willingness to lend. This circumstance should nourish a constructive feedback loop between the financial sector and the real activity.

This could do more to unstick toxic assets than anything else since it makes price discovery much easier and believable. It won’t do much for home building though, Kohn notes, since the inventory overhang will keep starts sluggish over the next year.

And the bias on inflation remains down.

I expect that inflation will likely be subdued, and that, for a while, the risk of further declines in underlying rates of inflation will be greater than the risk of increases.


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