A few weeks ago there was some discussion about the prospects of a double dip. I try to stay out of the fortune-telling business, as I don’t believe I or anyone else can predict the cycle better than markets. But one line of reasoning that I found less than convincing was the argument that monthly car sales and monthly housing sales are already quite low. And other parts of GDP aren’t that cyclical. We know from the 1930s that things can get a lot worse. If NGDP falls sharply, RGDP will also fall sharply.
But it’s only fair to point out that a month or two later those making the optimistic case (for avoiding the double dip) seem vindicated (knock on wood.) If so, I’d point to another factor—monetary policy.
In the 1930s the Fed was incredibly passive; hence there was no floor on NGDP, or at least a very low floor. Since 1982 the Fed has been following something close to a Taylor Rule. As long as nominal rates are positive, markets have confidence that shocks won’t drive NGDP much lower. Remember how bleak things seemed right after 9/11? RGDP actually rose in the 4th quarter of 2001.
In my view there is still a floor on NGDP, even at zero rates, because the Fed still has some credibility. But the floor is much lower than when rates are positive. The upshot is that while there might be a mild downturn, I’d be shocked if we had a severe recession. That’s not to say it can’t happen, but it would certainly be inconsistent with Fed behavior over the past couple of years, when they have used various unconventional stimulus tools when things looked especially bad. I suppose my biggest fear would be a fast moving crisis, perhaps centered in Europe—with the Fed again letting bygones-be-bygones, and settling for growth rate targeting.
There’s no reason anyone should take any of my hunches seriously. I didn’t predict the Great Recession until the markets did. And if there’s another dip, I won’t predict it until the markets do. All I’m saying is that visualizing the likely Fed response function is the most useful way to explore the possibility of a double dip, not whether various categories of RGDP “can’t go any lower.”