Excerpt from John Makin's latest commentary:

There is a connection between the necessary, rapid easing of monetary policy by the Federal Reserve and the sharp increase in global food and energy prices that is feeding back onto the United States as a contractionary force by reducing real purchasing power. The currency pegs to the dollar of some large, rapidly growing countries, including China, Russia, and Brazil, in effect make the Federal Reserve the central bank of those countries. Steep cuts in interest rates by the Federal Reserve to help cushion the impact of the bursting of the housing bubble have created a huge inflow of funds in search of returns to these same emerging market countries, as well as India and Middle Eastern oil exporters. The attempt to peg their currencies to the dollar forces those countries to produce rapid increases in liquidity that, in turn, stimulate demand growth for food and energy products. So by pegging their currencies to the dollar, those countries are forcing more adjustment in the United States to higher energy prices. The more the Fed eases to accommodate credit strains in the U.S. economy, the more money floods abroad into emerging market countries and pushes up their energy prices. Beyond that, energy prices are held below market levels by governments such as that of China so that as their economies grow more rapidly, the demand for energy expands even faster without any discipline from higher prices, and so inflation in other sectors rises. The estimated effective oil price inside China is about $60 a barrel--half the full international market price. Rapidly rising inflation and accommodating central banks have resulted in negative real interest rates in most emerging countries--a further spur to more inflation. The corollary is that energy prices have to rise more in the United States in order to slow the global growth of demand for food and energy products.

Higher food and energy prices feed back negatively onto U.S. and developed economies in two ways. The higher inflation hurts the terms of trade of the developed countries and compresses real wages and profits. U.S. real wage growth has already dropped below zero, while profit compression is becoming more intense as U.S. companies, facing higher input costs, are unable to pass on the higher costs through price increases in a slowing U.S. economy.

Excerpt from John Makin's latest commentary:

A detailed examination of Japan's lost decade may lead some to conclude that America's current problems are not that serious. The lessons for American policymakers in 2008, however, are clear, and it would be unwise to ignore them. An economic cycle driven by a collapse in the market for an asset--such as land or housing--to which the banking system is heavily exposed is a dangerous beast. One lesson that we shall probably be learning this year is that conventional measures like prompt policy interest rate reductions by the central bank and some fiscal relief for households and firms are necessary but not sufficient conditions to return the economy to health.

Excerpt from John Makin's latest commentary:

A stimulus package like the one under discussion in Washington can, like the measures in 2001 and 2002, be expected to provide at best a modest, temporary lift to growth, equal to a two-quarter rise in the annual GDP growth rate by about 1 percentage point. The actual impact of the current plan will probably be about half that for two reasons. First, the sharp one-third rise in energy prices during 2007 is the equivalent of an $80-$100 billion tax increase on U.S. households that will have boosted unpaid credit card balances. About one-half of a windfall tax increase will probably be used to pay down debt and therefore will not add to spending, although it will help to improve household balance sheets. Second, the rapid onset of recession and the associated wealth losses tied to falling stock prices and home values have increased uncertainty and reduced tolerance for risk by firms and households. These factors increase the likelihood that tax rebates will be saved, while investment incentives provide less stimulus to add to plant and equipment.

Excerpt from John Makin's latest commentary:

The underlying cause of the problems in the financial sector is a persistent fall in house prices....The U.S. housing stock is worth about $23 trillion, so a 15 percent drop in house prices represents a wealth erasure of $3.45 trillion over a period of about two years. That figure represents about a quarter of annual GDP or about 12.5 percent of GDP per year for two years...

Excerpt from John Makin's latest commentary:

The principal/agent problem--where interests of managers of financial intermediaries diverge from those of their shareholders--has been clearly illustrated by the widely publicized cases of Merrill Lynch and Citigroup. Substantial errors in initially reported third-quarter earnings, when revealed, resulted in the "resignation" of the CEOs of both institutions--Stan O'Neal of Merrill Lynch and Charles Prince of Citigroup. For those who review these sad cases, it is tempting, but untrue, to say that financial firms take too much risk because they are managed by foolish people...

Excerpt from John Makin's latest commentary:

...the cost of avoiding recession after the biggest housing bubble in American history has burst is too high. It will involve rewards to those who took excessive risks that will only result in more underpricing of risk in the future, and therefore larger bubbles and, ultimately, a more unstable economy that underperforms expectations.

Excerpt from John Makin's latest commentary:

The next six months will show how well the world economy and the U.S. economy can perform without a strong contribution from U.S. consumption growth. The credit- and housing-fueled growth of U.S. consumption at a persistent 3 percent rate over much of the last several years will not continue and could turn negative in coming months. Meanwhile, U.S. capital spending will also probably slow, as will spending on non-residential construction. A U.S. recession is likely, despite the Fed's move to address lower growth by cutting interest rates. The Fed's initial easing move usually coincides with the onset of a recession. Weaker global demand growth will be exacerbated somewhat by the continued weakness of Japanese consumption, but that is not a new factor.

Excerpt from John Makin's latest commentary:

Almost unnoticed amidst the credit-market turmoil in the housing-driven Anglo-Saxon economies was Japan's quiet slippage into ominous negative growth. Sharp downward revisions to second-quarter capital spending that appeared early in September resulted in a negative 1.2 percent annual growth rate for Japan's overall economy--somewhat shocking in view of the fact that the initial reports on the quarter had put the growth rate at above 2 percent.