Wednesday, October 14, 2009

Kohn, The Fed's No. 2 Man, Says No V-Shaped Recovery

I a speech at the National Association for Business Economics in St. Louis (here), Donald Kohn said that he does not think a V-shaped recovery is the most likely outcome this time around.

With the collapse of the U.S. Dollar, demand for U.S. exports has obviously been increasing lately after falling sharply in the first half of the year. As we have stated here, this is the main reason that several companies will report good earnings.

Kohn says: "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".

On inflation, Kohn expects it to continue subdued, and he thinks 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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