The Unsustainable Must Surely End!
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The Unsustainable Must Surely End!. Michael Parkin. LECTURE TOPICS. OUTLINE. Consensus forecasts for 2003 Unsustainable trends Inflation or deflation?. CONSENSUS FORECASTS FOR 2003. My previous forecasts

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The Unsustainable Must Surely End!

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The unsustainable must surely end

The Unsustainable Must Surely End!

Michael Parkin




  • Consensus forecasts for 2003

  • Unsustainable trends

  • Inflation or deflation?

Consensus forecasts for 2003


  • My previous forecasts

    • At the MVEA meetings in Kansas City in February 2001, I predicted that 2001 would see recession.

    • At the MVEA meetings in Memphis in February 2002, I predicted that 2002 would see falling stock prices and a Dow of around 7000.

    • What’s next?

Consensus forecasts for 20031


  • Average of 37 professional forecasts

    • 2003(1)2003(2)2004

    • Real GDP growth2.53.54.0

    • Unemployment rate6.05.75.5

    • CPI inflation rate2.22.22.4

    • GDP deflator inflation1.71.72.0

    • 3-month T Bill rate1.251.82.8

    • 10-year T Bond rate4.04.65.1

Unsustainable trends


  • Unsustainable?

    • Three unsustainable trends that must surely end are

      • Rising real estate prices

      • Increasing household debt

      • The external deficit

    • A fourth trend, the federal budget deficit and growing federal debt is sustainable if the current official projections are correct but might become unsustainable if expenditures increase more rapidly than projected.

Unsustainable trends1


  • Rising real estate prices

    • From 1995 through 1999, stock prices increased at rates that were out of line with fundamentals.

    • From 2000 through 2002, stock prices decreased and returned to their fundamental equilibrium levels.

    • From 1995 through 2002, real estate prices increased at rates that were out of line with fundamentals.

    • During the next year or two, real estate prices will fall and return to their fundamental equilibrium levels.

Unsustainable trends2


  • Increasing household debt

    • As real estate prices increased, so did the amount that households borrowed on mortgages and consumer credit instruments.

    • When real estate prices return to their fundamental equilibrium levels, a number of households will have a balance sheet problem—their debts will exceed the value of their assets.

Unsustainable trends3


  • The external deficit

    • Each year since 1992, the United States has had a current account deficit.

    • The deficit was small at first but it has relentlessly increased.

    • By 2002, the deficit was running at more than $400 billion—4 percent of GDP.

    • Net foreign indebtedness increased by $2.25 trillion during the past decade.

Unsustainable trends4


  • Government deficit and debt

    • After only four years of surplus, the federal budget is again in deficit and is projected to remain so indefinitely.

    • Net government debt is projected to grow from $3.6 trillion in 2002 to $5.1 trillion in 2008.

    • Net debt will grow from 34 percent of GDP in 2002 to 36 percent of GDP in 2008.

    • If expenditure follows the projected path, this situation is sustainable.

Inflation or deflation


  • Internal adjustment pain

    • When real estate prices return to their fundamental equilibrium levels and households cope with the ensuing balance sheet problem, the saving rate will increase.

    • Real GDP growth will slow and perhaps turn negative for a year or so.

Inflation or deflation1


  • External adjustment pain

    • While the rest of the world is willing to hold U.S. debts, the international deficit is not a problem.

    • But when foreigners decide to move their wealth to Europe, Asia, Central and South America, Australasia, and Canada, U.S. debt will be dumped and perhaps quickly.

    • The dollar will slide and perhaps quickly.

    • The dollar is even today beginning to look less robust.

Inflation or deflation2


  • Conflicting effects

    • Falling real estate prices will be deflationary.

    • A falling dollar will be inflationary.

    • Which will occur first?

    • My guess is that the real estate bubble will burst first and it will trigger a dumping of U.S. assets by foreigners.

    • Will we have deflation or inflation?

Inflation or deflation3


  • The critical role of the Fed

    • Whether we have deflation or inflation depends on the response of the Fed.

    • If the Fed continues to mimic a Taylor rule, we’ll most likely have no major change in the long-term inflation rate.

    • All the current signs point to inflation of between 1 and 3 percent a year.

Inflation or deflation4


  • If the Fed gets it wrong

    • If falling real estate prices bring financial stress and the Fed doesn’t keep money growth strong, deflation could occur.

    • If the Fed tries to resist a falling dollar with interest rate hikes, deflation could occur.

    • There is a bigger risk that the Fed will err on the side of deflation than on the other side.

The unsustainable must surely end

The Unsustainable Must Surely End!

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