Before turning to those issues, however, I would like to provide a brief update on the outlook for the economy and policy, beginning with the prospects for growth. Despite the unwelcome rise in the unemployment rate that was reported last week, the recent incoming data, taken as a whole, have affected the outlook for economic activity and employment only modestly. Indeed, although activity during the current quarter is likely to be weak, the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so. Over the remainder of 2008, the effects of monetary and fiscal stimulus, a gradual ebbing of the drag from residential construction, further progress in the repair of financial and credit markets, and still-solid demand from abroad should provide some offset to the headwinds that still face the economy. However, the ongoing contraction in the housing market and continuing increases in energy prices suggest that growth risks remain to the downside.
What Bernanke is arguing -- correctly I think -- is there are two sets of forces at work.
On one hand we have a bottoming in housing, credit market repair and exports helping to ameliorate the effect of high energy prices and the housing slowdown. Some of this hangs on when housing will bottom out, and as I have repeatedly asserted, I don't see that happening anytime soon. Simply put, supply is still massive, demand is still weak and lenders are facing tremendous headwinds from a tightening of their balance sheets. These are not conditions conducive to healing.
Oil's chart has been rising since early 2007. That's a strong rally to kill. In addition, the summer months are typically a period of higher prices, so we're arguing against a strong historical trend. In addition, we've got 2 billion people (India and China) with higher standards of living. So I don't see that dropping anytime soon.
The only good news here is in exports, which should do well so long as the dollar remains cheap. And given the sorry state of the Federal government's finances, I don't see that changing anytime soon.