What's Next for The Economy?

Last Updated Aug 10, 2011 8:43 AM EDT

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In the last two weeks, the stock market has approached bear market territory, buffeted by instability in Europe, the stand-off over the debt ceiling, weak economic reports, and of course, Standard & Poor's downgrade of the U.S. credit rating. These developments have caused many to wonder if the American economy might be headed towards a dreaded "double dip" recession. To help make sense of all the recent news and data, MoneyWatch spoke with Dr. Dan Seiver, a visiting professor in the finance department at San Diego State University.


MoneyWatch: The Dow has been up and down hundreds of points in the last few days. What does this volatility tell us about the state of the U.S. economy?
Dan Seiver: The U.S. economy is going to be weaker than most of us thought. It's going to struggle for the rest of this year and the rest of next year. That's a serious concern because that affects employment, unemployment, corporate profits, business confidence, household confidence, and our ability to get through the last part of the housing mess. You combine that with the fact that monetary policy has pretty much done everything that it can. The federal government, after all the debt ceiling shenanigans, has probably got its hands tied, and will probably move toward fiscal restraint even though the economy hasn't recovered enough. That will certainly make things weaker. Wall Street is not imagining all of this, which it sometimes does when it collapses. This is really happening.

MW: What do you think is the significance of S&P's downgrade of U.S. debt?
DS: Our bonds are still among the safest in the world. Interest rates actually fell after the downgrade. We will never default in any meaningful economic sense, but we have already defaulted in the political sense. There is no political will in Washington to either rescue the economy now, or to fix our long-term fiscal imbalance. The downgrade reflects the political default. As for the stock market, the recent decline made stocks much more attractive for long-term investors.

MW: Do you think investors are worried about a second recession?
DS: The market is having a correction. The stock market can correct without the economy suffering greatly. If you look at the 1987 market crash, which was much worse than a correction, you have to parse the data really finely on a monthly basis to see any real economic blip. Of course, the Fed was able to intervene. That made a big difference. Still, the market can do crazy stuff without it affecting the economy. I think what the market is reflecting now is that there will be this weakness. It still is a fairly good leading economic indicator.

MW: Is this sort of prolonged malaise we've been experiencing unusual?
DS: It's not surprising if you are familiar of the book by Carmen M. Reinhart and Kenneth Rogoff, This Time Is Different: Eight Centuries of Financial Folly. It's a long slog, but I read it last year and I think it's a really good discussion of the last 400 years of financial crises in the world, sovereign defaults, and so on. The essence of the data they collected is that when you have a credit collapse along with an economic collapse, the recovery is often really, really slow and takes years. That is the reality that is finally sinking in.

MW: How does our current crisis compare to others in history?
DS: It could have been much worse. I mean if the Fed hadn't awakened from its regulatory slumber in time to deal with the collapsing economy, we would have had another Great Depression. You and I would be sitting over some little fire with a stick through a can of beans trying to keep warm. It would look like the end of the world. They prevented that, but still it was a horrendous calamity.

MW: Do you think that a double dip recession is possible?
DS: Yes, it's a distinct possibility. I wouldn't want to rule it out. Economists don't have such a stellar record of forecasting, though. My guess is that we know enough that we can avoid an actual second recession. But it could happen. If we make enough mistakes, it will happen.

MW: What kind of mistakes?
DS: If we try to balance the federal budget instead of letting it run at a big deficit to help support the economy, we could throw ourselves into a really nasty second recession. So, bad policy could certainly cause it. I think good policy could help us scrape by without actually another recession. We could have tepid growth like the kind reported [recently], not enough to really make a dent in the unemployment, but enough to at least keep the economy staggering at least forward a little bit.

MW: What can we do to help the economy, aside from avoiding mistakes?
DS: Since I'm not a politician, I can suggest that what the economy needs is more stimulation. That's not a popular thought now, but if the Fed can't do any more, it's got to be fiscal policy. The fear that Americans suddenly have, that we're bankrupt, is completely false. We're not bankrupt. There's no reason for us to ever go bankrupt. You have to run deficits when the economy is sick and, in fact, maybe even increase them. So we need something to push the economy forward.

MW: Such as what?
DS: If you want something more lasting than leaf raking or ditch digging, why not invest in infrastructure? Our infrastructure has deteriorated a lot. The payoffs to that are pretty high. Work on roads and highways and bridges and building schools and building out a new version of the Internet. There is a lot that we can invest in -- including in education, only you could argue I'm a biased observer. We could do a lot that I think would have a long-run benefit, but would also create some short-term stimulus to help push the economy through what is still, obviously, a very difficult time.

MW: What do you think is the outlook for employment?
DS: For Americans who are looking for work, it's going to be a tough slog for at least another year, I would think, at the rate things are going. I think we're going to see, at best, very slow, staggering growth. That's not good for anybody. I'm sure the Obama administration doesn't like looking at that picture.

Photo courtesy of SDSU
More on MoneyWatch:
How Markets Have Responded to Past Downgrades
What the Debt Deal Means for Jobs and the Economy
The Latest Jobs Report: Moving Sideways Isn't Good Enough