The value of flexible response to an economic downturn –

With Euroland GDP turning negative and the dollar strengthening, an obvious question is how come the headline risk of the US economy has not been captured in the GDP numbers. Second quarter GDP was 1.9%. This is slower and the fourth quarter 2007 was revised to negative, but this is not a recession by the definition of two negative GDP quarters.

The US economy is supposed to be ill, yet like a good medical practice the US has done a better job of helping the sick patient. The help was available because there are less constraints on the US economy to engage in old time Keynesian “pump-priming". Given medicine to make you better is not a cure, but it helps relieve some of the pain. The medicine for the US economy has been a responsive monetary policy which has dropped rates from 5.25% to 2%. In addition, the Fed has allowed for flexible lending facilities for both banks and brokerage firms. It has also taken the lead to reduce systematic financial risk through the sale of Bear Stearns to JP Morgan. The Treasury has taken the lead to provide some solutions for the housing mess and the GSE debacle. Congress passed a housing bill to provide emergency funds for housing. The President offered tax rebate program that added to second quarter GDP.

The response in Europe has been less aggressive. The ECB has not lowered rates and has focused only on inflation fighting. granted there has been an increase in some lending facilities but there has not been a clear objective for trying to grow EU economies. The fiscal side has not had the same level of aggressive action as in the US. Hence there has been a slide in European growth as many of the same credit and housing issues are taking a bite into the economy.

Region	Monetary policy	Fiscal policy
United States	Fed -Inflation and growth objectives	Flexible response – no constraining deficit limits
Europe	ECB - Inflation target as sole objective	3% deficit to GDP - EU limit

Europe is less flexible in their potential policy responses to a recession. There may be a better safety net for workers, but the likelihood of stronger European growth to drive the rest of the G7 is not likely. The dollar strength is less liely to be reversed in this type of environment.