Business Forecast 2010: An End to the Recession or a Stalled Recovery?

by Phil Rockrohr
Photos by Matthew Gilson
Business Forecast 2010

Image by Matthew Gilson

Unemployment will hover around 9.5 percent, and real housing prices will continue to drop. But faculty panelists at Business Forecast 2010 predict economic growth in the year ahead, even as political mistrust continues to rise.


Randall Kroszner, a recent Federal Reserve governor, pointed out, “Largely due to actions the Fed took, we are in the Great Recession rather than the Great Depression.” Kroszner, Norman R. Bobins Professor of Economics, served the Fed from March 2006 to January 2009.

Real GDP will climb 3.4 percent, but the unemployment rate will remain elevated in 2010, Kroszner said. “We’ve been losing jobs at a declining rate, which is about as much of a smile as you’re going to get out of an economist,” he said. “The data are going to be choppy, but probably before the middle of 2010, the U.S. economy should see growth in payroll jobs. It’s going to take a little while longer for the unemployment rate to start to come down, likely during the second half of the year.”

Kroszner said the good news is that productivity levels are at all-time highs. “The strength of the productivity numbers is quite astonishing,” he said. “Some commentators argue the shock has fundamentally reduced productivity in the economy, but that’s really not the case. As a result, we will be able to step back relatively strongly.”

 Kroszner was among faculty panelists who shared their expertise on political and economic challenges ahead at Business Forecast in Chicago in December at the Chicago Hyatt. The event drew nearly 1,000 alumni, students, and members of the business community and gave them a chance to pose questions that ranged from whether government investment in infrastructure was a realistic way to spur economic growth to what impact health care reform might have on the economy. It was one of five forecasts worldwide.

The Role of the Federal Reserve

Thanks in particular to its new power to pay interest on reserves, the Federal Reserve has the wherewithal, the will, and the tools to extinguish its unprecedented level of reserves without causing high inflation, Kroszner said. “The $800 billion of excess reserves has a lot of inflationary potential, but because the Fed can now provide interest on reserves, it can raise the rate paid on those reserves to keep the opportunity cost constant as interest rates go up. It can now for the first time also offer interest-bearing term deposits to the banks to reduce the incentive for banks to lend out those excess reserves. Thus, the Fed has new instruments that, while by no means perfect, will be very important in managing the exit strategy from the period of an extraordinary amount of liquidity in the system to prevent explosive inflation.”

Both Kroszner and Erik Hurst, V. Duane Rath Professor of Economics and Neubauer Family Faculty Fellow, warned of the potential dangers of stripping the Federal Reserve of its “invaluable” independence. A proposal to allow the Government Accountability Office to expand its authority to cover Fed monetary policy would essentially create opportunity for investigation and undue pressure from Congress, Kroszner said.

“The Fed is likely to be deciding to raise interest rates when unemployment rates are far above where the Fed has ever been willing to tread before,” he said. “But the pressure that would come from the enactment of this proposal is likely to make it much more difficult for the Fed to do the job it needs to do. There are many challenges ahead for 2011, particularly if the Fed’s independence is in question.”

The Fed’s independence is important to macroeconomic stability because research shows that policy makers, such as Congress and the president, tend to think in more short-sighted terms about the economic policies they prefer, Hurst said. “Why? Because they might run for reelection tomorrow, and how the economy is today might reinforce their election potential,” he said. “In a world where policy makers have a direct effect on monetary policy, you might get them to stimulate the economy more in the short run than might be optimal for the long run of the economy.”

Increasing demand by keeping interest rates low and spurring investment puts much more pressure on prices and tends to result more in inflation, Hurst said. “Unemployment usually corrects itself in the long run,” he said. “Eventually, labor markets clear, everybody goes back to work, and the economy chugs along its merry way. Inflation rates are very hard to get rid of for us as policy makers. With weak central banks that are at the whim of the legislature or the president, you tend to get higher inflation rates.”

Hurst was happy to report that his “take it to the bank” prediction at last year’s Business Forecast that housing prices would fall about 10 to 12 percent in 2009 was on target. In fact, he stood by a second prediction for 2009 that prices would hit bottom during the fourth quarter of 2009 or the first quarter of 2010, give or take a quarter. “Nominal housing prices have reached their bottom, but real housing prices will continue to erode for the next three or four years or so,” Hurst said. “This is good news for lenders because their loans are in nominal dollars.”

Hurst agreed with Kroszner’s prediction that the economy will grow in 2010, but he emphasized that recovery will occur very slowly, in large part due to “the chicken and the egg” story of economic uncertainty and economic activity. 
“Uncertainty over policy, economic activity, and the loan portfolios of banks are all sitting around in the background,” he said. “How do you get consumers and businesses to spend in a world where there is increased uncertainty and they want a forecast? You wait until the economy starts to get better. And the economy starts getting better when consumers start spending a little more, businesses start spending more, and they stop hoarding their cash.”

For that reason, among the GDP-recovery graphs discussed in the media, the U shape makes the most sense, Hurst said. “The debate is once we hit the bottom, how fast will that economic activity sitting on the sidelines—consumer savings in case of unemployment, and businesses withholding investment in case of rough times—get redeployed?” he said. “I’m on the side that says it will take some time to undo this uncertainty.”

Political Mistrust on the Rise

As recession and recovery drag on, the humiliation, anger, and mistrust that powered politics in 2009 will be heightened in intensity across the world, including the United States, said Marvin Zonis, professor emeritus of business administration. U6, the broadest measure of unemployment in the country, has reached a post-Depression high of 17.5 percent, Zonis said. To make things worse, the homes of 332,000 Americans were foreclosed in October 2009 alone, and 7 million more foreclosures are projected, he said. “These are the realities driving humiliation and anger in the United States. in 2010,” Zonis said.

President Obama’s approval ratings have fallen almost in perfect correlation with the state of the economy and rising unemployment, he said. Given the likelihood that unemployment will not diminish soon, Obama’s approval ratings will continue to drop, Zonis said. “Even members of his own party will take advantage of his weakness to seek more federal funds for their constituents,” he said.

Republicans will “smell blood” and win a substantial number of House and Senate seats in 2010, but probably not enough to overcome Democratic majorities, Zonis said. “To slake rising popular anger, Democrats will use their majorities in 2010 to adopt populist measures such as serious anti-market financial regulation and a second stimulus bill,” he said. “That stimulus bill will not, of course, be called a stimulus bill. It will instead be called a ‘jobs promotion’ bill.”

In political economy in general, 2010 will be marked by “wicked problems,” Zonis said. “Wicked problems are characterized by two phenomena,” he said. “Number one, they are really complicated, intractable, and may be impossible to solve. Two, the very effort to solve such a wicked problem may in the end create new wicked problems. That’s what we’re looking forward to in 2010.”

For example, in Afghanistan, Obama will send an additional 30,000 troops, but it will become virtually impossible to withdraw them by July 2011, Zonis said. The United States will distance itself from the corrupt, ineffective regime of President Hamid Karzai and begin working with and spending large amounts of money to build local militias, warlords, and tribes, he said. “We will have many more allies there by the end of 2010, but the government will be just as impotent and ineffective,” Zonis said.

The current regime in Iran will survive, but is so under attack that Grand Ayatollah Hossein Ali Montazeri, the most senior and highly esteemed cleric in Iran, issued a statement declaring the political system “condemned and illegitimate” for its “Stalinist methods and Medieval torture,” Zonis said. “That kind of powerful, sweeping statement from an esteemed cleric will trouble the regime deeply in 2010 and weaken its ability to withstand global pressures now squeezing it very badly.”

Although he conceded complete failure in predicting the deaths of global political leaders for 2009, in his annual “death watch” Zonis delivered a bold political prophesy for 2010. “We will finally see the end of Osama Bin Laden and Ayman al-Zawahiri, given the new U.S. efforts in Pakistan,” he said. “Pakistani intelligence knows where these people are, and the U.S. will put a full-court press on them in order to locate them and have them killed.”

Despite his somber outlook, 2010 will likely be better than 2009, Zonis said. “When you put it all together, 2010 is likely to be a less threatening year economically, politically, and militarily,” he said. “Of course, there are numerous wild cards out there that could result in vastly costly outcomes. But, bewildered as I am, who knows?”


Booth Experts Weigh in at Five Forecasts around the Globe

The Chicago forecast kicked off five events across three continents, where expert panelists shared economic and political insights for the year ahead. Topics ranged from housing to credit, from emerging markets to the U.S. Federal Reserve Bank. Prognosticators in New York, London, San Francisco, and Singapore weighed in at the local, national, and international levels before a combined audience of more than 1,400 alumni, students, and business professionals.

 “The facts belie the gloom of most forecasts earlier this year that the recession would last into 2010.”
     — Michael Mussa, AM ’70, PhD ’74, at the Waldorf Astoria in New York December 3  

“I’m unconvinced this recovery will be 
   slower than average for other recessions.”
     — John Huizinga, Walter David “Bud” Fackler Distinguished Service Professor 
of Economics, at the London campus December 4

 “This is interesting to me because it says there is  nothing  inevitable about 3 percent average growth forever in a mature economy at the economic frontier.”         
     Steven Davis,  William H. Abbott Professor of International Business and Economics, on the 
slowdown in Japan’s economic growth, at the Singapore campus December 14

 “All in all, we suffered for about 1.5 years, but there is no more free fall, and the recovery is here. But there are serious challenges ahead.”
    — Bernard Yeung, MBA ’81, PhD ’84, at the Singapore campus December 14

 “Sound fiscal positions rely much on a credible path regarding the consolidation of public finances.”
     — Lorenzo Bini Smaghi, PhD ’88, at the London campus December 4

Find full coverage of Business Forecast, including video links, an audio slideshow narrated 
by Huizinga, and full stories from each event

Last Updated 3/4/10