Noting that bad economic news tends to make headlines, the authors highlight the positive economic developments of recent months and present a case for guarded optimism with respect to the economy's nascent recovery. Private domestic demand – the key ingredient to a sustained expansion – has seen a strong burst of activity of late, fueled by a 17.6 percent annualized increase in business investment. This would not have been possible without some thawing of credit markets. Signs that credit conditions are easing, especially for small businesses, are encouraging, as they suggest that monetary stimulus is getting through to the real economy.
"While there is a case for optimism, what we really strive for is realism, and it is true that the bears of this world have not had major difficulty finding reasons to be negative," the authors write.
Growth in domestic demand has slowed in the current quarter, and will likely continue to slow as business investment comes off its initial growth spurt and home sales decline in the aftermath of the expired homebuyer's tax credit. Just as important, job growth, while consistently positive in 2010, has also been sluggish. In a recession and recovery characterized by private-sector deleveraging, a slow improvement in personal income growth will act as a natural constraint on private demand growth.
The recovery will continue to present challenges for policymakers, who face an electorate weary of record deficits and big bailouts. While economic growth will continue to be positive, it is not likely to grow fast enough to bring down the unemployment rate in the near term. On the fiscal front, any new stimulus measures must be balanced against the need to bring down budget deficits in the future. For the Federal Reserve, the main option for further stimulus is an even greater expansion of its balance sheet, which could complicate the removal of stimulus once economic conditions normalize. Indeed, neither the politicians nor the monetary authorities are in an enviable position. In all likelihood, economic growth will continue to improve and stimulus will be gradually withdrawn. However, with so little margin of error between positive and negative growth, policymakers will stand ready to step in with greater stimulus should it be warranted.
