Hunkering Down, Part Deux

Echoing themes from yesterday's post, Gary Stern, President of the Federal Reserve Bank of Minneapolis, referred in a speech this morning to the ongoing "credit crunch," which he describes as "an environment in which quality borrowers find credit either unavailable or available only on very expensive terms." This causes delays in investment projects in both the private and public sectors. Stern expects this drag on the economy to last 1-2 years.

The Fed is trying furiously to pump liquidity into the economy by lowering interest rates, but lenders are not cooperating. "Many large banks," according to Stern, "both here and abroad, have found it desirable to protect balance sheet capacity in the wake of unanticipated asset expansion and material financial losses." In other words, they are being much more cautious about originating new loans.

Once we work through this period of "dysfunctional" credit markets, Stern expects annual GDP growth of 2.5%, not exactly rip-roaring (below the 3.0-3.5% of the past 55 years). And looking even further out, he sees shortfalls of tens of trillions of dollars in Social Security and Medicare. Did you catch that? Tens of trillions! In rather dry language, Stern calls these shortfalls "unsustainable and difficult to address." Well, yeah.

Stern's advice: think about cutting back on entitlements. "If debt financed, such deficits are likely to restrain growth over time through their effects on interest rates and, in turn, the consequences for investment, capacity, and productivity. If tax financed, there could be disincentives to work and/or to invest depending on the form of the increases, and the implications for growth would likely be negative. Finally, if program benefits are to be scaled back, it is far preferable to take this step sooner rather than later so that potential beneficiaries can plan appropriately and adjust."